RCS Investments Global Macro Outlook 2014

8/13/2019 RCS Investments Global Macro Outlook 2014

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| Rodrigo C. Serrano, CFA| SIPA | Columbia University

Master of InternationalAffairs 14 Candidate

| New York City, NY| 01-305-510-0181

| [email protected]

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-./01223 % 4506 7186 98:6 ;-./01223< * 4506 7186 98:6 ;-./01223) Europe needs growth, not juststabilization.

While the Eurozone crisis has somewhatebbed, its repercussions will remain a keydeterminant of the macro landscape over

the coming year. If economic growthdisappoints in the coming months, expectrenewed turbulence.

Few Choices Left for Citizens

The roughly 3-year-old plight hastransformed the political landscapethroughout the region, retarding thedemocratic process. In Greece, the center-right New Democracy party is allied withthe center-left Pasok party. In Italy, SilvioBerlusconis center-right Forza Italiawithdrew its support from a coalition withEnrico Lettas center-left Democrats party,having since been replaced by a defectingcenter-right faction (the New CentreRight) led by Angelino Alfano. Austria,Finland, and the Netherlands sport similar

pro-European alliances in an effort tosupport the Eurozone project. Thesepartnerships have effectively blurred theidiosyncratic ideologies of the participatingparties, leaving voters without an effective

political outlet. Meanwhile leaders withabsolute majorities have seen their supportdwindle as campaign promises have goneunfulfilled, as has been the case for FrenchPresident Franois Hollande and to alesser extent for Spanish PresidentMariano Rajoy. In fact one could say thatthese leaders have served merely asfigureheads imposing dogmatic butdestructive economic policy, crafted bytechnocrats in Brussels with a Germannod.

Overall voters have been repeatedlydisillusioned with the false promise ofbetter economic conditions as well as a lackof control over the direction of policy. Thishas led to their increased flirtation withmore extreme parties, which seem to be thelone viable outlet left. As a result, anti-


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Moreover he said he would not feelcompelled to follow Europe if its in thehands of bureaucrats. While Mr. Renzisrhetoric would inflame tensions with

Brussels and Germany, his pact with Mr.Letta means that this issue will unlikely bea short-term concern.

Lettas government must movequickly to turn the intensifying anti-eurotide. Joining Mr. Grillos 5-StarMovement is Forza Italia, headed by SilvioBerlusconi. Combined, both currentlyrepresent an anti-euro faction with wider-reaching public support than the current

pro-European coalition. Additionally, theIForconior Pitchfork movement, an anti-euro camp initially of farmers and truckersthat began in 2011, has grown to includestudents, pensioners, and strugglingbusiness owners.

French Divergence Leading to Despair

In an effort to mold the states economy toconform to the aforementioned 3% annualbudget deficit parameter by 2015, Mr.

Hollande has largely resorted to fiscaladjustments instead of structural ones.This year the deficit is estimated at 4.1%; in2014 it is expected to fall to 3.6%. Theresult has been a deepening lack ofcompetitiveness, stemming primarily from5 consecutive years of draconian taxincreases next year will feature a 75% taxon millionaires as well as an increasingrisk of a triple-dip recession.

Building Europe and subduingGerman might have been principalcomponents of Frances foreign policy eversince World War II. It has always seen

itself as an equal ofBundesrepublik.However, this has now changed. Frenchpublic opinion is ever more anti-euro. Theproject has weakened the nations standingand has been primarily a result ofGermanys austerity policies. News ofMarine Le Pens National Front partyleading in the polls has led Steeve Briois,Secretary General, to proclaim that TheFrench are showing a wish to take theirdestiny into their hands and give back their

country its sovereignty. As stated byAmbrose Evans-Pritchard, The split ineconomic performance between Franceand Germany cannot continue for muchlonger without causing severe politicalstrains.

Recovery now the Elixir of Political Will

On December 17 Merkel signed off on aGrand Coalition between the CSU/CDUand the SPD. For struggling Eurozonenations, this represents a welcome change;for the SPD has stated it supportssolidarity in advancing the project. Inspite of this, initial indication from the newgovernment is that it will be business asusual in dealing with the Eurozone, astrategy overwhelming approved bycautious German voters. As has been thecase over the past few years, financialassistance will come in exchange for fiscalrigidity. German sacrifice would come, if

the project were in danger of unraveling.This tit-for-tat arrangement has beenfeasible due to strong domestic economicgrowth. How would it be politicallytenable to support other countries, ifconditions were not satisfactory at home?"#$##

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It is no secret that Germanys breadand butter lies in exports. It will bepivotal for this sector to operate near or atfull capacity in 2014. Yet, the current

trend remains feeble. The global recoverymust gain momentum.

A healthy export sector would mutepotential headwinds of upcoming andexisting Germany policies such as: a newminimum wage demanded by the SPD(likely to price out low wage workers), acontinued push to eradicate all nuclearpower by 2022 (raising electricity pricesfurther), and an underwhelming amountinfrastructure investment. In addition to a

fragile rate of growth in exports, jobgrowth has disappointed. Germany is notas strong as many believe at this point.

In the periphery it will be crucial forthe recovery to become ensconced. Whileinvestors have cheered at the fact thatstabilization has arrived, this will not beenough to truly mark a turning point in the

crisis. Lack of a strong region-widerecovery would mean record highunemployment rates in Spain, Italy, andGreece. In the case of France 16-year high

unemployment would persist, fueling anti-euro sentiment. The crux of the matter isthat austerity/recession fatigue is at anextreme. The current economicenvironment must improve.

To be sure, leading indicators signalthat growth is set to arrive; it could notcome any sooner. Improving region-wideeconomic activity would undermine anti-euro sentiment, decreasing an already

dangerously high level of political risk.The climate for reform would also improve.Slowly but surely, falling unemploymentrates would give people hope that theworse has passed, providing an incentivefor further sacrifice, since they would bealmost at the finish line. In Germanyfulfilled promises by the periphery wouldgive leaders confidence to continuegranting financial support to strugglingnations Greeces bailout money from theIMF and European countries is set toexpire this coming July. They would alsotake key steps in consummating themonetary union, such as using theEuropean Stability Mechanism to closedown failing banks, initiating a region-widedeposit insurance scheme, and ultimatelyissuing Eurobonds. In effect, a positiveeconomic/political feedback loop woulddevelop.

The ultimate bullish scenario of a

consummate monetary union in its currentform remains largely wishful thinking.Asymmetric growth, a hallmark symptomof a non-optimal currency area, is clearlyon display in Italy, France, and Greece.Even with recent signs of stabilization, thecurrent state of affairs is clearly untenablefrom a social standpoint. Lack of definitive

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On October 20thJapan became alarmedwhen a Chinese drone was spotted flyingover the Senkaku (Diaoyu in China)Islands. Japan claimed them as rightfullytheirs after purchasing them from privateownership on September 11thlast year. Inresponse, new Japanese protocol waspublished that declared the right to shootdown any drone that trespassed its airspaceand ignored orders to leave. ChinasMinistry of Defense promptly re-escalatedthe incident by declaring that downing oneof their drones would constitute an act ofwar.

Roughly one month later, onNovember 23rd, China moved to assert itsclaim over the archipelago by establishingan Air Defense Identification Zone(ADIZ). Not only does the zone cover theislets, it also covers a large section ofJapans own ADIZ.

(Map: The Economist)

On the 25th, the U.S. sent 2 unarmed B-52bombers through the zone as part of along-planned exercise, clearly an act ofdefiance to the recent Chineseannouncement. Japanese and SouthKorean aircraft have entered the zonewithout notification numerous times aswell. China has remained silent on theencroachment. This recent developmenthas turned into a near-term risk for theglobal recovery. Military conflict wouldpit the 2ndand 3rdlargest economies in theworld against each other and could disruptmajor energy trade routes in the SouthChina Sea.

Chinas action has been seen by manyas destabilizing the status quo in theregion. It has led to Japan increasing itsdefense budget by 5% over the next 5 yearsand announcing that this coming Spring

recommendations would be made by anational security panel on lifting thecountrys self-imposed pacifist policy ofself-defense. It has given the U.S. arenewed urgency in executing its AsianPivot, in order to communicate itsincontrovertible security commitment tothe area; this after President Obama


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missed Asia-Pacific Economic Cooperationand East Asia conferences both in earlyOctober, as a consequence of thegovernment shutdown.

Despite the hoopla caused by thecircumstance, there are reasons to behopeful. Japan and China conduct a lot ofbusiness and investment with one another.Economic dependence has long beenknown as an effective deterrent againstconflict. Furthermore both countries havetheir plates full in terms of fostering thedomestic economic expansions, on whichtheir governments survival depends.

Regardless of the economic reasons tonot pursue military conflict, Japan andChinas nationalistic leaders will find ithard to back down from their escalations.Furthermore the U.S. will be hard-pressednot to increase its military presence in thearea and show its most valuable Asian allythat it has its back. Whats more, triplecoverage of territory in the East China Sea South Korea expanded its ADIZ tooverlap Chinas and Japans ripens the

situation for an accidental clash.

Taken together all nations involvedwill go through great pains to avoidconflict, while attempting to save face athome. However, an elevated probability ofan accident similar to the Hainan Islandincident in 2001, which involved a mid-aircollision between a U.S. spy plane and aChinese fighter aircraft, may occur, leadingto a period of financial risk aversion.

However, leaders would find a way todefuse the situation. Beginning a war, onthe basis of claiming a few uninhabitedrocks, which would seriously disrupt thefragile global recovery and place bothcountries governments at risk, would beutterly foolish.

>) Japan: Are the clouds parting, or is itthe calm before the storm?

Abenomics, the term used for Shinzo Abes

three-arrowed cocktail of intense monetaryeasing (a doubling of the money supply),strong doses of fiscal stimulus, and far-reaching structural reform have resulted ina roughly 50% rally in the Nikkei stockmarket index and improved performance inbusiness indicators, such as industrialproduction and export growth (due to alower yen). These policies have been putinto place to achieve a virtuous cycle ofrising wages, leading to increased

spending, investment and employment.Whether it succeeds or not may profoundlyaffect the economic and financial landscapeover the coming year. Its success remainsyet an open verdict.

Wages are rising shrinking! Aprils a coming.

Haruhiko Kurodas monetary policyof quantitative and qualitative easing(QQE), which has stoked nationalheadline inflation to a 5-year high of 1.2%

YoY, has enjoyed the most favorableattention. A notable portion of thisincrease has been due to a lower yen,leading to increased costs of energy andimports. Core inflation remains subduedbut at least in positive territory at 0.6%, thehighest in 15 years. Be that as it may, theeffectiveness of inflation as a spark forconsumer spending depends on the pace ofwage growth.

Earnings growth has thus far laggedbehind rising prices. This has effectivelysqueezed real disposable income andaffected confidence.


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Mr. Abe, cognizant of how pivotal it willbe to reverse this budding relationship, haspleaded with companies to raise wages togive consumers more spending power.Early 2014 will be important as they make

their compensation plans. They will needto feel confident that business conditionsare improving in sustainable fashion.Slowing economic growth over the pastyear wont help.

This seemingly lackluster set up comesbefore a watershed moment for Abenomics.Beginning April, an increase in thecountrys sales tax from 5 to 8% will mark

the biggest test of whether Mr. Abesvirtuous cycle has begun to settle in.Consumption is likely to increase in the runup to the hike, as households push forwardtheir purchases to avoid the tax. It will bethe months after that will yield the verdict.

Similar to the Eurozone, Japanscondition also highlights the need for astrong global recovery to boost exports andsustain the economy, should weakness in

consumption become protracted.

Debt dynamics: Weve Heard this Before.

Japan is saddled with the worlds largestgross debt pile, projected to be 242% ofGDP in 2014, according to the IMF. Thisfigure is roughly 40% higher than the nextmost indebted country (Greece); 82%higher than currently criticized Italy, andmore than double that of the U.S. Whilethis worrisome state of affairs is nothing

new and many have warned of an acutedeterioration in the countrys finances inthe past, it particularly merits attention dueto recent developments. First, a recap ofthe long-standing factors

First: Japanese 10-yr interest ratescurrently stand at roughly 0.7%, whichtranslates to an interest expense of roughly20-25% of the governments revenue.Rising global interest rates would pressure

this cost higher quickly: 2% interest rateswould raise costs to nearly 80% ofgovernment revenue, according to AsiaConfidentials James Gruber. This factorhas not proved a headwind in the past inpart due to Japans decades of deflationaryconditions. Interest rates have continued

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to fall since the crisis began. How long willthis trend persist?

Second: Japan faces a decliningpopulation and workforce. As a potentialoffset, government could enact policies

aimed at increasing the labor force.However, at nearly 80% for men, whichsurpasses participation rates of other high-income countries, and 61% for women,which closely matches the U.S. metric of62%, Abes administration will find it quitedifficult to offset the principal trend.

The government could also targetproductivity enhancements to offset thefalling number of workers. According to

Martin Wolf of the Financial Times, aneeded rate of 2.5% productivity growthwould be a tall order, No high-incomeeconomy achieved trend productivitygrowth so high between 1990 and 2012.The area in most in need of higherefficiency lies in the countrys traditionalservice sector.

Third: A declining population alsohas important implications for moneyflows. As workers retire, their need for

liquid financial resources rises. This meanspensions and retirement funds will need toliquidate investment assets (partiallycomprised of Japanese bonds) to providefunds. This will be an increasing headwindfor government-sponsored, fixed incomeinstruments in the years to come.

Whats new?

Two factors have materialized that raisethe stakes further. On March 11, 2011, the

T!hoku Earthquake, the 4thmost powerfulearthquake in history and the strongest tohit Japan since records began, produced atsunami that ultimately triggered theFukushima Daiichi nuclear disaster. Thecatastrophe lead to Japan haltingproduction of nuclear energy, whichconsisted of 30-40% of the countrys powersupply, substituting it with imports.Recent public opinion remains resolutelyopposed to using nuclear energy any time

soon. Japans current account standinghas since deteriorated to flirtation withdeficits. Imports are close to exceedingexports. Japan is losing its status as a netcreditor nation. Investors may begin toquestion how the country will continue toservice its debts since money flows arealmost outwards on net.

(In billions of yen)

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>) China: What lies in store for theglobal economys arcanum?

China remains a key cog in the global

recovery. A significant slowdown ingrowth, below 7%, would reduceworldwide aggregate demand needed foreconomic growth in periphery Eurozonecountries. Japans export-reliant economywould lose steam. President ObamasNational Export Initiative, which promisesto double exports by the end of 2014,would fall into serious jeopardy.

Two-Way Street

Inasmuch as the internationaleconomy needs China for continuedgrowth, by no means is it a two-way street.To maintain growth over the coming year,officials in the commerce ministry haveexpressed increased dependence onrebounding demand from developedcountries, U.S. and Europe in particular.So far the news has been positive. Firmingbusiness activity within the worlds largesteconomy and stabilization in Europe have

recently provided headway for Chineseexports; 12.7% YoY growth in Novemberwas the strongest result in 7 months.

A stronger global recovery will beneeded to buoy fragile, domestic economicgauges. In addition to a reduced pace ofexpansion in industrial production, growthin fixed asset investment has also slumped.Meanwhile consumption, which accordingto the World Bank in 2012 stood at a

paltry 34.6% of GDP compared to a worldaverage of 60% and 68.6% in the U.S., hasnot emerged as a serious candidate torescue these ailing sectors.

Additionally higher exports would act asan insurance policy for developmentduring the multi-year implementation ofthe most far-reaching reforms since 1978.

The 3rdPlenum of the 18thCentral Committee

Not since Deng Xiaopings 3rdplenum ofthe 11thCentral Committee, which openedthe nation to foreign markets and signifiedthe beginning of a dizzying resurgenceonto the global stage, have Chinese leadersemphasized the importance of the 4-daymeeting that took place on the 9thofNovember. In a determined effort to openthe door of Chinas Bird Cage economy,

officials have established a panoply ofreforms aimed at further liberalization,emphasizing decisive results by 2020.

Business analysts attention was mostdrawn to markets playing a decisiveversus a fundamental role in theeconomy, a clear nod that a model of

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reduced government interference is underdesign. This could entail a large-scalemetamorphosis of various state-ownedenterprises (SOE). In addition to

ordaining these firms to direct more oftheir profits to the public purse, they arealso prescribing a larger divesture ofprofits instead of retention. Even moreradical, deliberations in allowing privateownership of firms in sectors notconsidered to be the lifeblood of theeconomy, or deemed important to nationalsecurity, have been publicly stated. Rural-dwellers will incur more property rights.On the real estate front, a property tax will

be introduced to temper rising homeprices. Reforms will aim to increasecompetition and urbanization. Corruptionlooks to be confronted. These and otherreforms will be supervised by a leadingsmall group, which some speculate will beheaded by the General Secretary XiJinping himself. These reforms are seenby many as pivotal for a better China andlong-term and sustainable globaldevelopment. But implementation risk

looms.

Xi Jinping: So Far an Obfuscating Leader.

Notwithstanding these reputable reforms,which would lead investors and worldleaders to believe that Mr. Jinpingunderstands the importance of maintaininga sound incubator for growth, recentactions have left many flummoxed. Theestablishment of an ADIZ over the EastChina Sea and a Defense Ministry

announcement that it would establishother air defense identification zones at anappropriate time after completingpreparations has raised fears of a secondADIZ being established in the SouthChina Sea. This would be a big deal inenergy markets. The U.S. EnergyInformation Administration remarks

Almost a third of global crude oil and overhalf of global liquefied natural gas (LNG)passes through the South China Sea eachyear. Why would Mr. Jinping risk

alienation of important trading partnersduring a vulnerable moment in Chinaseconomic development? Perhaps to divertattention from poor economic conditionsby fomenting nationalistic sentiment? Ormaybe it is the latest example of Chinaslong-standing incongruous foreign policy,an issue to be addressed by the plenumannouncement of a new state-securitycommittee.

Another example of the inconsistentnature of Mr. Jinpings actions is therecent bugaboo of threatening to withholdvisas for Bloomberg and New York Timesbureaus operating in the country. On thebusiness front, numerous prominententerprises have been subject toinvestigations and laws curbing theiroperations, all the while markets will beplaying a decisive role in the economy.While all these actions will not detercontinued investment China is just toobig and compelling from a businessstandpoint to withdraw from they serveto show the capricious nature of Chinasmost powerful leader.

Financial Tremors

Beijings 1994 fiscal reform reduced the taxintake of the countrys provinces. Before,they were in charge of collection andpassed an amount over to the central

government. While the economy grew, taxrevenues did not rise in sync, the result ofprovincial mandarins snatching their fairshare of the proceeds. The establishmentof a central tax ensured the federalgovernment of its portion of economicactivity at the expense of the cantons.


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Chinas provinces have long beensalient actors in executing Beijingsdirectives. During the 2008 financial crisis,under the command of then Secretary

General Hu Jintao, a $586 bln economicstimulus plan was unveiled to battle theadverse effects of a slumping globaleconomy. Local governments wouldprovide "of the funds. With reducedrevenues and the enormity of the funds tobe dispersed, they began to borrow fromthe powerful state-owned banking, andlater on the shadow-banking sectors,mostly via the creation of local governmentfinancing vehicles (LGFVs). Questionable

investments in infrastructure and pet-projects were made with the ultimate goalof providing economic activity to counterthe export slump. Meanwhile state-ownedenterprises were pressured by thegovernment to keep production lineshumming, despite lack of demand, in orderto preserve and grow payrolls.Skyrocketing unemployment would havespelled doom for the communist party.Have the adverse results of these policies

begun to materialize?In mid-October Fitch Ratings

warned that the economic efficiency ofChinas debt was plunging. Each yuan ofdebt produced only 0.18 yuan of GDPgrowth. Unproductive infrastructure oneof many ghost cities sports a replica of theEiffel Tower and Champs Elysee andreal estate speculation on the part of localgovernments in search of enhanced returnshave brought increased scrutiny onChinese banks. While large-scaleurbanization may provide for demand inthe coming years for housing andinfrastructure, markets have gotten antsy;two financial tremors have been felt, one inmid-June and one currently ongoing.Chinas 7-day repo rate, a key measure ofthe cost of interbank lending, has recently

spiked on worries of overvalued bankassets (ie loans to local governments, state-owned enterprises, real estate developers,and other industries). Whether the

increase in interbank lending costs issimply due to a scramble for cash tocomply with year-end regulatoryrequirements, or a sign of a nascent creditcrunch is something investors will be keenon deciphering over the coming weeks.Unfortunately money market rates mayremain volatile due to the Lunar New Yearoccurring on the final day of January.Demand for cash tends to rise in the daysapproaching.

What lies ahead?

The plenum has produced admirable goals.However, the delicate state of the globaleconomy makes their execution fraughtwith danger. Cropping overcapacity, amajor focus over the coming year, will be aheadwind for development. A pick up inglobal trade would be bullish to offset.Help would likely come from some sort ofstimulus package if growth disappointed.Meanwhile, powerful vested interestsensure a high level of implementation risk.Among other impediments, localgovernments, fearful of job losses withintheir jurisdiction and falling tax revenue,may challenge objectives.

On the financial side, liberalization ofinterest rates, a form of markets playingthe decisive role, may yield unintendedconsequences. Higher deposit rates would

shave banks profit margins and drawfunds away from the real estate sector.Furthermore, weaning the economy off ofcheap credit would result in reduced ratesof economic growth due to a falling pace ofcredit expansion.


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Chinas ghost cities are an example ofa gross misallocation of capital. A fairshare of these debt-financed ventures willsour. Non-performing loans will rise.

While central government officials recentlyannounced that they would not bailoutprovinces and local governments, they willeventually relent. Many of these debtswere incurred due to Beijings decree onNovember 2008, the nadir of the financialcrisis.

Global trade needs to rebound. TheU.S. economy is accelerating which bodes

well for Chinas exports. Attention shouldbe paid to money market rates for clues onwhether banking troubles are picking upsteam. Will relations with Japan improve?

The path to sustainable growth for China isriddled with mines. A top governmentthink tank mentioned how growth nextyear would be supported by a gradualrecovery in exports. This marks thecommunist country handing off the batonto the U.S. and Europe. Can they holdserve? The communist party certainlyhopes so.

>) Wave of Uncertainty to come from the Fed

On December 18th, Chairman Ben Bernanke finally pulled the trigger. A reduction in theFeds QE program from $85 to $75 billion in monthly purchases of Treasuries and mortgagebacked securities was the result of a potent 4.1% third quarter mark in annualized GDPgrowth, a 5-year low in the unemployment rate, stabilizing consumer demand, and risinghome prices. Over the summer, the mere suggestion of a tapering was met with turbulentsell-offs in emerging market currencies, U.S. Treasuries, and to a lesser extent equity markets.This time around, U.S. indices rallied on execution, not suggestion, of tapering. U.S.Treasury prices did not fall with the ferocity exhibited over the summer months. Emerging

market currencies, such as the Mexican peso and South African rand, shot up on the news.This time investors took tapering as a sign of genuine strength in the worlds largest economy.Furthermore, tapering has no longer been seen as tightening to many. Liquidity remainsabundant, and in fact the Fed is still easing by purchasing assets. Even better, furthertapering would be data-dependent; officials could delay a further cut back in purchases.

A Different Gadget. But Why?

Yet, the latest Fed announcement introduced a novel tool for investors to counterbalancetapering. Stating that short-term rates would remain near zero well past the time that theunemployment rate, now 7%, declines below 6.5%" was new and ultra-dovish. Forward

Guidance serves as an indication to investors, business, and consumers of how the Fed intendsto conduct monetary policy in the future. In this case, it has made clear that rates wouldremain low for a prolonged period. This would therefore place downward pressure on longer-term interest rates since theyd be close to zero at that point in time. Lower interest rateswould translate to lower borrowing costs for households and businesses. However, some areskeptical of the efficiency of forward guidance. Stanley Fischer, previously the head of theBank of Israel and in line for the vice chair position at the Fed, voiced his opinion that thefuture is inherently unknowable; therefore investors would discount the Feds own forecasts.


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Furthermore this policy could raise the risk for reputationaldamage, if it suddenly became probable that they wouldhave to backtrack on a stated promise. The tapering of QEand introduction of forward guidance is likely to ferment

uncertainty over the coming months.

Despite optimistic sentiment, due to robust perform-ance of risk assets in the days following these announce-ments, its important to ask why the Fed has chosen to shiftgears, despite concern of the efficiency of this new policy.After all, an unemployment rate of 7% and a personal consumption expenditures price indexof 0.9%, versus the Feds target of 2%, both signal a sizable failure to achieve the institutionsmandates. The most important reason is that many worry that loose monetary policy hasdistorted asset prices, splitting them from economic fundamentals, a sentiment I share. Thisencourages perverse risk-taking behavior on the part of investors as they embrace the

Bernanke Put. At the sign of market distress, the Fed would step in and buy more assets.While some at the Fed have expressed these serious reservations, their points have beenrepeatedly out-voted when making policy decisions.

Meanwhile, a slowly recovering economy and theexpiration of the payroll tax holiday early this year hasresulted in rising federal revenues, up 10% in the first twomonths of fiscal 2014 (October and November) versus thesame two months of last year. Meanwhile the sequester hasreduced government spending, which fell 5% over the sameperiod versus last year. Taken together they have rendereda 22% decline in the fiscal deficit over the same period a

year earlier. A falling deficit translates into reduced issuance of government debt. Meanwhilethe supply of mortgage-backed securities, the other asset being purchased by the Feds QEprogram, has fallen due to a weakening demand for housing. As these quantities decrease, theFed ends up buying a larger share of the total issuance. Peter R. Fisher, Senior Director atthe Blackrock Investment Institute, estimates that if asset purchases continued at their currentrate, the Fed would soon be buying up all new Treasury and mortgage-backed security issues.

(Continued)

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Chart: RCS InvestmentsSource: Bureau of Economic Analysis

The ed is running outof stuff to buy--Peter R. Fisher--

Senior Director at theBlackrock Investment Institute


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RCS Investments Global Macro Outlook 2014