Water Cooler Wisdom 1Q12Water Cooler Wisdom 1Q12A great deal happened in the world during the first quarter of 2014. The ECB may be pursuing quantitative easing, the Federal Reserve continues to send mixed messages about tapering, China is slowing down, the U.K. is set to grow the faster than any other advanced nation, and Gwyneth and Chris have split…or have they? According to the International Monetary Fund, the global growth outlook is positive, although the recovery is somewhat shaky and uneven. While there is a widespread fear of deflation worldwide, the hawks still stand by their position that uncontrolled inflation may still be in the future. In this economic environment, it is necessary to sift through a significant amount of noise to see the real economic picture.

The United States economy continues to grow but it is not going gangbusters. The polar vortex, along with the seemingly unending winter weather in the Eastern part of the United States, slowed economic growth during the first quarter of 2014. Regional economic indicators, including vehicle sales and employment, increased during the somewhat more temperate month of March, undoubtedly leaving residents and businesses looking forward to sunnier weather ahead. The unemployment rate remained unchanged at 6.7% and GDP increased by 2.6%. According to some analysts, the current inflation rate of 1.6% (see: Consumer Price Index) represents a lower bound to US inflation, The Federal Reserve continues to be committed to tapering but it seems somewhat reluctant to say ‘when’ due to continued concern about inflation. While the market will likely continue to experience spasms at every word Janet Yellen breathes, it may be more business as usual for the Fed in the near future.

Equities (see: Returns and Valuations by Style) have increased slightly but remain in what some would consider normal territory. It is important to note, however, that some sectors of the equities market have increased by 275.2% since the market low in March 2009. Overall, the market growth is not enough to risk substantial changes in inflation or interest rates but also not slow enough to decelerate overall growth. Essentially, it’s smooth-sailing.

As of April 9, 2014, the Office of the Comptroller of the Currency, the Federal Reserve and the FDIC approved a new rule requiring the eight largest U.S. banks to greatly increase their leverage ratio (essentially, they need to hold more capital). This rule is in response to the increased emphasis on macro-prudential regulation and the fact that many are still shaking in their boots from the aftershocks of the Global Financial Crisis. This rule will help to ensure that systemically important banks have the capital to lend in any economic environment, guarding against a credit contraction if market conditions were to negatively change. This may mean easier lending for smaller banks whose leverage ratio is not quite as high but since this rule does not take effect until 2018, the real results are yet to be seen.

Since the start of 2014, the discussion of unconventional monetary policies has been more, well, unconventional. The European Central Bank may be in the process of become policy bedfellows with the Federal Reserve, Bank of Japan and Bank of England by implementing quantitative easing as a monetary policy tool. The ECB has been considering this as well as negative interest rates to protect from decreasing inflation. These negative interest rates would affect deposits at the ECB since these banks would be required to actually pay to park their money. The monetary policy motive for this would be that these banks, avoiding the extra ‘tax,’ would rather lend out their money to the private sector. This would spur growth and ideally protect against the low inflation. Quantitative easing is a little trickier for the Eurozone. Whereas the US and UK can purchase bonds from their own individual markets, the ECB has 18 countries to choose from. Buying from France could give an unfair advantage, whereas purchasing bonds from Greece could throw Germany into an uproar. Some economists suggest that the ECB purchase Treasuries from the Fed to help unwind our rounds of quantitative easing. What a ‘taper tantrum’ that might cause.

While the economy is improving, there is still a long road ahead. However, given that holding cash yields a 0% return, it is still an attractive time to invest, regardless of the current interest rate climate (see: Asset Class Returns). So, go out, get invested, become diversified and have a wonderful spring.

Laurel Mazur is Castle Rock Investment Company’s Research Associate. Laurel Mazur is a graduate student at the University of Denver pursuing a dual Master’s degree in Economics and Global Finance, Trade, and Economic Integration. Most of her research and writing focuses on international monetary economics and central banking. She can be reached at Laurel@CastleRockInvesting.com.