The State of the Real Economy

The U.S. reported very good growth numbers for Q4/09, and manufacturing data and ISM indices indicate that Q1 growth should come in strongly too--the one recent blemish is February's non-farm payrolls number. This is important, because it highlights the fact that employment is still not recovering. With no growth in real wages, weak consumption growth and deleveraging households, it is not clear where private demand might arise (or is arising). As PIMCO notes, the growth numbers could very well be driven by inventory rebuilding and fiscal stimulus.

To put the unemployment issue in perspective, I quote David Rosenberg of Gluskin Sheff, an eternal pessimist throughout this crisis (bold emphasis mine):

"While... it could well be argued that we are entering some sort of healing phase in the jobs market... the reality is that the level of employment today, at 129.5 million, is the exact same level it was in 1999. And, during this 11-year span of Japanese-like labour market stagnation, the working-age population has risen 29million. Contemplate that for a moment; fully 29 million people competing for the same number of jobs that existed more than a decade ago. That sounds like pretty deflationary stuff from our standpoint."

The last comment about deflation is, I think, also really important, because the strong economic data is not having much of an effect on bond yields, with these staying low across the term structure. QE has obviously contributed to this, but maybe part of the story is that yields are so low because the market in fact does not believe in the strength of the recovery, and expects a benign inflation outlook and policy-makers to keep rates low. As Bloomberg writes:

"Treasuries indicate traders are paring bets inflation will accelerate. The difference between yields on 10-year notes and comparable TIPS, a gauge of trader expectations for consumer prices, touched 2.22 percentage points, the lowest level since Dec. 14. The so-called breakeven rate reached the intraday high for this year of 2.49 percentage points on Jan. 11."

Going forward, it is crucial to keep re-evaluating this combination of low rates/benign inflationary expectations yet seemingly robust growth.