The world’s central banks believe they have done their job and that it’s time for political leaders to do theirs; returning to stability and prosperity should be a shared responsibility. According to the Bank for International Settlements (BIS), colloquially known as the central bankers’ bank, “cheap and plentiful central bank money” has merely bought time. What markets round the world are ignoring about monetary stimulus is that it is not there to make life easy for financiers – it is there to compensate for the ongoing, violent adjustment still needed in most economies to correct the distortions that gave rise to the financial crisis. The most dangerous aspect of the efforts of central banks is that it deludes the private sector from making its own reforms; “low interest rates and unconventional monetary policies have made it easy for the private sector to postpone deleveraging.”

Domestically, the financial markets have settled down after the recent Bernanke-induced spike in volatility. It would be nice to believe that some rationality has returned with investors focusing more on underlying fundamentals rather than obsessing about the deceleration of Quantitative Easing (QE). Understanding the timing and nature of the Federal Reserve’s eventual exit strategy is of course important, but there has been too much focus on the issue of whether QE will start to be scaled back in September or December.


The key issue for the U.S. markets is the growth outlook for the domestic economy. This will dictate the path of Fed policy and the direction of bond yields and equity prices. Nonetheless, there are some lingering risks of economic disappointments in the near term, implying that bond yields could drift lower and stock prices could face renewed turbulence. However, economic growth should improve later in the year and through 2014, putting bonds yields on a rising path and pushing equity prices higher. With interest rates still relatively low, it will be a while before interest rates rise to a level that triggers a new bear market in stocks.


The government’s spending sequester may remain a modest drag on activity for another few months, keeping third quarter growth in the 2% to 2.5% zone. But the picture will then start to improve. The reason for cautious optimism is that some of the economic headwinds of the last few years are diminishing, while the tailwinds will still be in place.

  • Housing activity has ceased to be a drag on growth and there is considerable upside in construction activity
  • State and local government finances are on the mend with even California recording an operating budget surplus
  • Household deleveraging is well advanced and should be a diminishing headwind going forward
  • Better business sector confidence promises faster growth in capital spending

Needless to say, the news is not all good; federal fiscal policy and government regulation seem unstable, and the global backdrop remains challenging for U.S. exports.


The Fed’s optimistic forecasts imply favorable GDP growth in late 2013 and 2014, but the Fed’s actions will be dictated more by labor market and inflation trends than by GDP growth rates. Bernanke has a deeply-engrained fear of deflation; thus, there are low odds of the Fed making a policy error by withdrawing its stimulus prematurely – i.e., before the economy is on solid footing. The recent sell-off in Treasuries sparked by Bernanke’s talk of tapering QE needs perspective; the dislocation in the Treasury market was not so much the recent sharp rise in yields, but the fact that they had fallen so low in the first place. The sell-off has merely returned yields to a more normal level. In other words, the oddity was the low starting point of yields, not the end point. It would take major economic disappointments for the 10-year yield to fall back below 2%. Going into 2014, yields should resume an upward trend.


Equity markets swooned in June, but may retest summer lows. Volatility will continue to create opportunities, but will also add to near term risk. The backup in interest rates has made closed-end fund yields look attractive, especially amongst municipal and emerging market funds.



Michael Ashley Schulman, CFA

Managing Director