What I Learned in Italy (Or, Economies in Perspective)

I'm just back from a trip to Italy, where the economy is still in dire straights straits (h/t Kevin McMahon, who pointed out the incorrect use of the word...thanks for the edit!) When locals found out what I did for a living, they wanted to talk about the U.S. economy and my thoughts as to when the tide might turn for Italy and the rest of the PIIGS (Portugal, Ireland, Italy, Greece and Spain). When other U.S. travelers found out what I did for a living, they wanted to know when the rotten U.S. recovery would accelerate. Life is always a matter of perspective.

Despite scary headlines during the time I was away ("Bonds dive!", "Japanese stocks plunge!", "QE to end!", "US growth lackluster!", "Jobs report is key!"), I keep thinking of an Italian saying, “ Niente di nuovo sotto il sole” (nothing new under the sun). Yes, there has been a flurry of turmoil seen over the past week and a half, but there is really nothing new under the sun. Let’s review.

Bond market crash: As predicted for the past two years, interest rates on government securities across the globe have finally started to rise. The U.S. 10-year treasury yield increased to 2.2 percent, up from about 1.6 percent at the beginning of the month, the worst monthly performance since December 2010. While the price drop and yield increase may seem dramatic in the short-run, it has been long-telegraphed by improving economic conditions.

Japanese stock correction: Investors started buying Japanese stocks last fall, but the gains accelerated after the recent Bank of Japan pledge to drive up inflation to 2 percent within two years, using a QE-type of bond buying and by doubling the nation’s monetary base. Yes, the Nikkei 225 has fallen 17 percent from its May 22nd peak and saw its first monthly decline in the past 10, but it remains up more than 25 percent this year.

QE to end: As signs of recovery continue, concerns are mounting that the Federal Reserve will have to taper its bond-buying program (“Quantitative Easing” or “QE”). While there is no doubt that QE will end, the timing and magnitude of the action is in question. Right now, bond market futures are pricing in a Fed rate increase in late 2014, compared with earlier expectations that interest rates would not rise until mid-2015. As economic conditions improve, some investors are worried that the Fed may withdraw stimulus sooner than later. Such action would lead to higher bond yields and lower bond prices and could potentially jar the equities markets as well. The central bank has said that it would maintain its low interest rate policies at least until the unemployment rate drops to 6.5 percent.

US growth: The government revised down its original estimate for Q1 growth to 2.4 percent from 2.5 percent and the second quarter is likely to remain muted, due to sequestration spending cuts. The pullback in government spending at the local, state and federal levels has been a headwind for growth during the recovery, but many are now predicting that 2014 could be the year that growth returns to the post-World War II average of 3 to 3.5 percent.

Jobs report (once again) is key: Here we go again…just as investors come off an anxiety-inducing week, the government will release a monthly jobs report on Friday. It is expected that non-farm payroll employment will increase by a 165,000 in May, and that the unemployment rate will remain unchanged at a four-year low of 7.5 percent. Helping to boost the numbers could be a resumption of larger growth for the construction sector.

Many will point out that the decline in the unemployment rate from a peak level of 10 percent in 2009 has been partially attributed to the exodus of discouraged people leaving the labor force. The plunge in the participation rate to late 1970’s levels has mostly been driven by demographics, as aging baby boomers retire. Still, about one-third of the decline is due to the severity of the recession and the weakness of the recovery.

See what I mean? Niente di nuovo sotto il sole!

For more, go to jillonmoney.com

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