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June 10, 2013

Economic Update

By Brendan Circle '14 and Heidi Zhang '14  |  june, 2013, Issue 1
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The global rally came to a pause on May 22 after the release of the FOMC minutes in which Ben Bernanke mentioned the need to sustain the Fed's current stimulus effort in light of below-target inflation, a weak labor market and the drag from current fiscal policy. The minutes, however, noted that "a number" of Fed officials were open to scaling down QE3 as soon as June if economic indicators sufficiently improved. Concern and confusion about these mixed messages put more volatility into the markets and the S&P 500 was down one percent for the week.

On May 23, the calm was further interrupted when the Japanese stock market declined by seven percent, the largest one-day selloff since the devastating earthquake and tsunami struck in March 2011. Besides Ben Bernanke's comments, other theories about the cause include a disappointing China Purchasing Managers' Index (PMI) or the Japanese ten-year government bond yield touching one percent. Even after accounting for the selloff however, the Nikkei has increased 67 percent since November. This run-up has been driven by a combination of fiscal and monetary policy easing under new Prime Minister Shinzo Abe and Bank of Japan Governor Haruhiko Kuroda, Abe's handpicked appointment. The drop in the Nikkei seems to indicate that some of the Abenomics euphoria may be wearing off, rather than a substantial change in the economic outlook for China or Japan.

As far as U.S. economic activity, the housing market's recovery marches on, with sales activity increasing in April. Rising inventories for new and existing homes should help sales gain further traction, as the amount of stock remains constrained. Consumer spending has held up in spite of the payroll tax increase but this positive surprise has been largely offset by weak government spending and soft demand abroad. The unemployment rate fell to 7.5 percent in April, with 165,000 jobs added overall and 176,000 added in the private sector.

Mention of a Fed quantitative easing exit likely created a natural point to take profits after the recent rally but the market has managed to avoid any significant pullback since November 2012, and dips have been used as buying opportunities. Even with the loss during the week of May 19, the S&P 500 remains up 15.7 percent for the year. This leads us to believe that in the face of negative headlines and potential market volatility, the growth potential for the U.S. is still supported by a revival in manufacturing, a rebound in housing and the move towards energy independence.

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