2012 economic outlook
Introduction
Catherine Gordon: Hi, I'm Catherine Gordon. Welcome to today's program. Joining me is Joe Davis, Vanguard's chief economist, and Peter Westaway, Vanguard's lead economist for our European office. Joe and Peter, thanks for being here today.Joe Davis and Peter Westaway: Thanks very much.
Assessing the year ahead
Catherine Gordon: So, gentlemen, it's that time of year. It's a new year and everyone wants to know—particularly given the headlines—what's going to be going on with the markets and the economy in 2012, and, in particular, what's Vanguard's view?
Joe Davis: I'm happy to take the United States. As many may know, expectations for this year on average among many economists and investment strategists is for the U.S. to grow around 2½% this year which, to give context, historically the United States has grown since World War II on average 3½% to 4%, so below historical averages, but a recovery nonetheless. I do have some concerns, in a sense, that the consensus forecast has United States growing 2½% for each of the 4 quarters of 2012. I think it's fair to say rarely, if ever, such a forecast has come to fruition. I think 2½% overall for this coming year is reasonable given some of the resiliency that we continue to see. And as we've spoken about before, Catherine, at the corporate level, corporate balance sheets still remain fairly strong.There's been modest progress on the consumer side in paying down debt. Some modest progress on the housing front, but those very statements also are part of the reasons why I have some concern that growth will very likely be much more uneven than I think the average investor may expect.
There are significant risks, which is why we could very well see some hiccups or slowdowns in growth at some point this year. Oil prices come to mind as one. Some of the issues with respect to the housing market—home prices have yet to fully stabilize. But I think much more importantly on all of our minds is what happens in Europe. So, I'm eagerly awaiting Peter's thoughts.
Worries about Europe
Catherine Gordon: Peter, since you're based in London and certainly bring the European perspective to the discussion, what are your thoughts on the future of the Eurozone, and do you think the currency for the countries in the Eurozone will still be the euro at the end of the year?
Peter Westaway: I think the short-term future for the Eurozone is very uncertain, but I do think that by the end of this year the euro will still be holding together. I don't think any countries are going to actually leave. Obviously, there's a risk that some of the weaker periphery countries, like Greece, could leave the euro area, but I think the costs for them of doing that would be incredibly high. Policymakers have even talked about the possibility of countries leaving the euro area, which is something that's roiled markets, but I think despite the risks, that's not in my central case.Catherine Gordon: Do you think Europe can avoid a recession this year?
Peter Westaway: No, I think there are too many headwinds now in Europe to prevent a recession, so I think my best guess would be something like a 1% fall in GDP in the euro area this coming year. The U.K. will have very soft growth, maybe about half of a percent. A number of factors are really dragging back on activity. Obviously, the fiscal austerity itself is very important in slowing down growth, not just in the weak periphery countries but even in some of the larger economies, like France and the U.K. But perhaps just as important, the uncertainly that surrounds this sovereign crisis means that firms and households are just very unlikely to want to commit to any serious expenditures while all this uncertainty is around. And so given all of those factors, I think we are going to see a period of soft activity this coming year.
Inflation and interest rates
Catherine Gordon: Given the focus on the debt, there's a school of thought that some investors are concerned that ultimately governments will try to print their way out of the debt problems. What do you think about that possibility?Joe Davis: Inflation currently by trend on average is actually close to its historical average of around 2%–3%. The U.S. bond market, which is a good barometer of future inflation expectations, expects the same, on average, for the next several years. It's our contention that that's a very reasonable expectation, although again, there's always risk around that central tendency. Why are they reasonable expectations? Wage growth is very tepid—that in and of itself is 2%. I know some fear that the Federal Reserve is printing money, but, quite frankly, they are all on excess reserve, which means they are not really being lent out, which is why bank credit growth is still very tepid. And so it's tough to really foresee, at least over the next 3 to 5 years, that we would have, say, a repeat of the 1970s or early 1980s, when the consumer price index rose [by] double digits in the United States.
Catherine Gordon: Let's spend a minute on interest rates given all that we've been talking about. What do you think are the implications for interest rates around the world, and how do you think bond investors should think about those issues?
Joe Davis: The concern of a rising-rate environment is on some investors' minds, just like this time last year. I think if we look at Federal Reserve policy in the United States, I think if we look at what could happen for U.S. growth and what could happen for U.S. inflation, and, given our comments today, the Federal Reserve has been very clear that they will be on hold keeping the fed funds rate near zero at least through the middle of 2013. I think when we look at those distributions and what could happen to growth and inflation, I think it's fair to say that the risk is that the Federal Reserve may be on hold longer than expected, perhaps even well into 2014. And that pains me, because of what that may mean for short-term interests rates and for those that are savers and money market investors. But I think much more important and which may impact, quite frankly, Federal Reserve policy is what the European Central Bank (ECB) is doing and how successful that may be for Europe's situation.
Peter Westaway: Certainly the ECB is a key player in the global economy at the moment. And, of course, there's a debate in Europe about interest rates, how long interest rates are kept low. The ECB has just reversed its previous increases, brought them back down to 1%. They could go even further than that. The Bank of England is indulging in more quantitative easing. But in many ways, the explicit policy stance is a bit of a sideshow. The most important thing at the moment for the ECB is what they do about the sovereign [debt] crisis and the question that so many people are asking is: Are the ECB [officials] going to step in more aggressively to try to bring down sovereign yields? And that in the end is one of the key factors that's going to help bring the crisis to some sort of resolution.
At the moment, the ECB is still waiting to see more evidence of better fiscal policy and more structural reform in the periphery and as we're seeing that, I think it's going to be more likely that the ECB steps in more aggressively. And in the end, [the ECB is] a key player in helping to bring some sort of resolution to this crisis. But it's not quite yet happened.
Catherine Gordon: I'm sure our investors appreciate those insights. Peter and Joe, thank you both very much for your time today.
Joe Davis and Peter Westaway: Thank you very much.
Catherine Gordon: And thanks to all of you for joining us today. We hope that you'll join us again for Vanguard's analysis of economic trends.
Notes:
- All investments are subject to risk.
- Investments in bonds are subject to interest rate, credit, and inflation risk.
- Foreign investing involves additional risks including currency fluctuations and political uncertainty.
- Stocks of companies in emerging markets are generally more risky than stocks of companies in developed countries.
- The performance data shown represent past performance, which is not a guarantee of future results.
- Diversification does not ensure a profit or protect against a loss in a declining market.
- U.S. government backing of Treasury or agency securities applies only to the underlying securities and does not prevent share-price fluctuations.
