Monday, June 15, 2015

Christine Lagarde: US Economy Returning to Growth, But has 'Pockets of Vulnerability'

The IMF performs an annual analysis of the health of the US economy and then does a report on it. In this IMF Direct blog article, Christine Lagarde provides a summary of the findings this year. 

In general, the IMF sees the US continuing slow growth, but with some risks to financial stability still present. This is consistent with what the IMF has said for some time now. Below are some quotes from the Christine Lagarde blog article and then a few added comments.

"IMF staff have just concluded their annual health check of the U.S. economy, and released their concluding statement.
This year we have also undertaken a Financial Sector Assessment Program with the United States. We conduct these once every 5 years for systemically important countries and it is a comprehensive exercise looking at the whole U.S. financial system."
. . . . . 
Economic outlook
"Yet again, the review took place against the background of a shaky first quarter for the U.S. economy. And we revised our growth forecast down to 2.5 percent for 2015. This is largely due to those factors that affected the first quarter."
. . . . . 
"As always, there are risks and uncertainties to the outlook. For example, further delay of the housing recovery and the strong dollar—notwithstanding the latest improvement in the trade balance—could be a drag on future growth. Nevertheless, when we look at the whole picture, we believe that growth in the coming quarters will be 3 percent or higher."
. . . . . . 
"Over the medium term, as we highlighted last year, there is still much work to be done. Our forecasts of potential growth are now around 2 percent—a far cry from the over 3 percent average growth rates we saw before the Great Recession."
This leads to our policy recommendations in three key areas.
  1. Monetary policy
"On monetary policy, as we have noted before, the Fed’s first rate increase in almost 9 years is being carefully prepared and telegraphed. Nevertheless, regardless of the timing, higher U.S. policy rates could still result in significant market volatility with financial stability consequences that go well beyond U.S. borders.
In weighing these risks, we think there is a case for waiting to raise rates until there are more tangible signs of wage or price inflation than are currently evident:    . . . . . . 

  1. Financial stability
"Our team has taken a detailed and comprehensive look at the health of the financial sector under our Financial Stability Assessment Program."    
. . . . . 
"It also seems clear that risks have built up during the long period of exceptionally low interest rates. Nevertheless, today, the data point toward a system with pockets of vulnerabilities rather than one with broad-based excesses. But we shouldn’t minimize these risks. These pockets could create serious, macro-relevant sources of financial instability both here and abroad. Some of our concerns include the migration of intermediation to so-called “shadow banks” and the potential for insufficient liquidity in a range of fixed income markets, particularly as these markets come under stress. I know that the U.S. authorities are investing heavily in understanding and assessing these issues."
. . . . .
  1. Fiscal Policies
"As we have said before, given our forecast of a steady rise in the public- debt-to-GDP ratio, it remains critically important to adopt and implement a credible medium-term fiscal plan. This requires actions on tax reform, social security reform, and steps to contain healthcare costs."
. . . . . . 
In conclusion:
  • We believe near-term U.S. growth prospects are good.
  • It is better to wait for stronger signs of inflation pressures and have an interest rate hike in the first half of 2016.
  • Even after the initial step to raise rates, a gradual rise in the federal funds rate will likely be appropriate.
  • And although important progress has been made to strengthen the U.S. financial system, there is more to be done to address the pockets of vulnerability
My added comments:
I will just add a few comments related to each of the three main areas listed above.
1- Economic Growth - Here the IMF once again revises its growth forecast downward after everyone badly over estimated the first quarter GDP in the US. They still think overall the US will slowly increase growth. But we have to be honest and admit that they and other economists have consistently been too optimistic in their forecasts. The Atlanta Fed forecast model has been the most accurate and it still shows a lower growth forecast than this one by the IMF (although the Atlanta Fed forecast has been increased in the last week). Also, the call by the IMF to wait until 2016 to raise interest rates supports Jim Rickards prediction that this would happen.

2- Financial Stability - Both the IMF and the Bank for International Settlements have issued repeated warnings about systemic risks for quite some time now. We have many of those documented here on the blog. In this article Ms. Lagarde mentions a couple of these risks. Shadow banking and "the potential for insufficient liquidity in a range of fixed income markets, particularly as those markets come under stress". We covered both the shadow banking warning and the liquidity warning here in earlier blog articles. The market liquidity problem has also been mentioned recently in articles by both Nouriel Roubini and Jim Rickards. I had a friend of this blog (who is a very high level banking expert) review the Jim Rickards article on this issue. He informed me that while there are real risks, he believes they are manageable risks. I believe this is the prevalent view within the system. You can see from the Christine Lagarde article that she is aware of the risks. She obviously thinks the risks will be managed because she is not forecasting they will lead to another major crisis.

3- Fiscal Policies - With the current political division and grid lock in the US, I think it is safe to say that none of the recommendations the IMF makes in this area will be adopted in the US any time soon.

Conclusion: This IMF Direct blog article is a good one to illustrate the different views out there on a big question we are following here on the blog. That question is whether or not we will get another big global financial crisis (worse than the 2008 crisis) that many are predicting?

Some credible analysts outside the system think we will get another crisis. Contacts I have within the system agree there are risks present, but believe the risks can be contained and managed. 

Readers should understand that there are some very good people inside the system who understand the systemic risks and understand why some outside the system are worried about them. They do, however, think that the efforts being made to contain the risks and prevent another major crisis will work. I don't find evidence in my research that suggests fear that another major crisis is imminent exists inside the system right now.

My own view is that there is an information gap between those inside the system and those outside the system that contributes to the difference of opinion on this very important question. Obviously, those inside the system have access to more information than those of us on the outside. Jim Rickards feels those on the inside are using the wrong models and will miss a coming crisis. We will continue to follow events here and provide the best information and analysis we can, given the information limitations we must work with. If we have readers working inside the system who are willing to comment on this important issue, your comments are welcome and will be reported here (without editing and only with your permission). 

Meanwhile, our advice remains the same. Readers should stay alert and informed. Readers should have a backup plan in mind in case another crisis does emerge, but not waste time worrying about it constantly. We will do our best here to help with the staying informed part.

No comments:

Post a Comment