We are frequently reminded how globally interconnected our economy has become. With that in mind, Jones Lang LaSalle's annual conference on real estate markets opened with Rebecca Patterson, Global Head of Foreign Exchange and Commodities at J.P. Morgan, providing a whirlwind tour of the domestic and international economy. Her observations are paraphrased below:
"For the U.S., Good News in the Private Sector; Problems in the Public Sector. S&P 500 companies are in better shape than they've been in decades. They are awash in cash as a result of cost-cutting undertaken in the crisis. Their share prices have recovered, and profits are bigger. Expect more mergers and acquisition activity and more share buy-backs. There will be more capital expenditure and more hiring in the private sector, but that alone is not enough to turn things around.
"Job creation was trending well in 2009, but since April 2010 it has hit a plateau. Weekly jobless claims are a key metric. We need to get that number (currently 450,000) down to 400,000 to get below 10% unemployment. So why are companies not hiring? Political and regulatory uncertainty. CEOs need confidence to pick up the pace. If there is a political shift in November, that could be a catalyst to stronger growth, but this is not the base case.
"The key indicators are (1) business confidence and (2) weekly jobless claims. If those do not show marked improvement, the next year or two will be marked by 'sub-trend' growth: a 2.6% GDP increase is expected this year, and a 2.4% increase is forecast for next year.
"Fiscal policy is the elephant in the room. The U.S. has a debt-to-GDP ratio that is among the highest in the world, and it is on the verge of being unsustainable. After mid-term elections, attention will turn to the Presidential election in 2012. States that have to cut spending, notably Florida, California and Arizona, will find it politically difficult to do so. The fear is that they do nothing. The U.S. has to get the budget deficit from 8% to 4% by 2013 to avoid serious consequences, and this will require both taxes and growth. While S&P and Moody's will be under huge political pressure to pull a punch, there is a real risk that the U.S. could see its AAA credit rating downgraded or put on a downgrade watchlist. That, in turn, will force institutional investors to sell U.S. assets. Countries such as Ireland, Greece, Portugal and Spain with debt-to-GDP ratios comparable or even better than that of the U.S. have already been downgraded.
"Monetary policy offers the best available policy tool. Fed Chairman Bernanke has indicated he's concerned that inflation is too low. Gold could go up to over $1300/oz. The markets are pricing in the Fed's interest paid on excess reserves (currently 0.25%) being reduced to 0%. This quantitative easing—the 'QE2' measurement'—pushes interest rates so low that investors shed Treasury bills for higher-yielding corporate bonds, thus incentivizing private economic activity.
"For Emerging Markets, the Cycle Turns in Their Favor. They were not as levered as the developed nations, and had no subprime-related issues. Their growth prospects are good. Their budgets are more balanced: deficits are less than 3% of GDP as a rule. They are prospering from international trade. Structurally, many emerging markets are developing a middle class, which generates an appetite for durable goods that benefits the U.S. Which countries do we like? Emerging Asia benefits from trade connections with China. Indonesia, Singapore, Taiwan, Malaysia, and Hong Kong look promising. All have a current account surplus. The Chinese have to sustain growth to create jobs and manage social unrest. Chinese GDP growth was 10% this year, and should be 9% next year."
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