The Normalization Expectation
Happenings in the bond markets and what they say about the economy and investing.
By Steve Van Order, Fixed-Income Strategist
The last five years have been anything but normal for investors. We might borrow the late, great, Marty Feldman's line and name it "Abby Normal."1 But the signs are multiplying that we may be on the verge of returning to a more historically typical market and economic profile - call it "Normie Normal" if you will. What might it mean for investors if the economy and markets stop being so abnormal?
Over the next few years, Fed research suggests that key measures of the U.S. economy will approach long-run projection levels. For example, the FOMC projects2 the annual pace of GDP growth over the next two years to be right on the 50-year average. Private sector economists and the financial markets have gotten in line behind the Fed's 2014 outlook as the trend of positive economic surprises has continued in recent months.3
So here we are again, with markets anxiously awaiting economic normalization. In 2013, those hopes were often dashed by unexpected factors. However, this time the "government shutdown" joker has been removed from the deck, a debt ceiling debacle seems out of play, and, though the euro-area joker can always pop up, we haven't seriously seen it since the summer of 2012. That's long enough for markets to effectively move on.
Thus, we start the year with the consensus outlook that the U.S. economy is nicely along the path to normalization: higher long-term interest rates and rallying equities are evidence that the markets are on board. For equity investors, the news could be especially good if a "Goldilocks"-like scenario develops – a combination of moderate growth and low inflation. With savings rates still near zero, a Goldilocks environment will encourage investors to favor riskier assets, even if traditional valuations of riskier assets become quite extended.
The normalization/Goldilocks scenario should persist if the economic data remain solid, but not so strong that it would force the Fed to accelerate its timetable for a rate hike. Currently the Fed has markets expecting a near-zero policy rate into mid-2015, but this is subject to change and really depends on the data. As long as saving rates remain near zero, and are expected to remain there, the party ought to continue.
1. As spoken by Feldman's Igor in Mel Brooks' Young Frankenstein.
2. Projections for GDP growth and the unemployment and inflation rates are the midpoints of the FOMC SEP central tendency range.
3. The consensus for GDP growth drag from fiscal policy in 2014 is estimated to be 0.4 point compared to 1.5 points in 2013. This does not account for a few ticks of additional drag that should result if Congress does not retroactively extend expired unemployment benefits.
This commentary represents the opinions of its author as of January 8, 2014 and may change based on market and other conditions. These opinions are not intended to forecast future events, guarantee future results, or serve as investment advice. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither Calvert Investment Management, Inc. nor its information providers are responsible for any damages or losses arising from any use of this information.