Headwinds for the US and UK economies

Headwinds for the US and UK economies

Economies in the UK and US are bright spots in the developed world, but not quite bright enough to instill confidence.

If there has been one trend across the developed world that has taken hold in the last six months, it is this: the British and American economies look increasingly healthy, and the Eurozone looks more anemic than ever.

This phenomenon is even more evident for Germany, which had previously seemed similar to the UK but now appears to be more like France. The momentum in the US and UK is not uniformly positive, however. Questions remain as to when wages and inflation will rebound, and how the Federal Reserve and Bank of England will normalize policy .

Unemployment on both sides of the Atlantic is trending in the right direction, and has even surprised policymakers with the pace at which it has done so. Unemployment is 5.9% in the United States and 6.3% in the United Kingdom. These figures are complicated by questions about broader measures of labor utilization, but are encouraging as a leading indicator.


Source: Federal Reserve, Office of National Statistics

GDP growth also points towards positive, if modest, changes in the economy. Annual growth in the US, after a surprise contraction in the first quarter, is 2.6%. Britain has grown even faster at 3.1%. Since 2010, these figures have meddled in between recession and recovery, but are finally showing budding growth.

Persistent headwinds

Wages in the US are growing at their fastest rate since the financial crisis. The problem is that the rate is still nearly zero, after accounting for inflation. In the UK, the same problem is perhaps even worse. Any pick-up in the rate might not even be on the horizon yet.

Some of the causes pre-date the most recent recession. Globalization and technological change have certainly altered how labor markets function, especially for the less-educated portion of the labor force, but cannot explain the situation these two Anglo-speaking countries now face.

David Blanchflower, labor economist at Dartmouth College, points to the slack in the labor market instead. As the economy improves and unemployment falls, workers continue to emerge from the woodwork, maintaining the slack that observers thought was disappearing. Some workers are returning to the labor force, some are simply looking for an upgrade from their current underemployment status.

Until labor force dynamics begin to normalize, wage growth will not be able to. Without wage growth, it will be difficult for consumer spending – the driver of both economies – to accelerate. Both the Federal Reserve and Bank of England have noted this, but given the difficulty in determining the health of a complicated labor market, their message has been muddled.

Inflation remains low

Wages are not the only thing growing too slowly. Inflation across the developed world remains at near-crisis lows. US inflation in August was just 1.7%, the twenty-seventh straight month it fell below the Fed’s 2% target. The Cleveland Fed estimates that inflation expectations will also remain below 2% for nearly 15 years. In the UK, inflation in September was even lower than in the US at 1.2%. Projections by the Bank of England show a rise to the 2% target becoming more likely in the next few years, but its assumptions about wage increases appear to be more optimistic than likely.

Nonetheless, inflation poses a political risk for the Fed and Bank of England. A small but vocal minority of market observers are predicting impending hyperinflation caused by accommodative monetary policy, which they have been unsuccessfully predicting for three years. With views similar to this permeating the committees that determine monetary policy through Charles Plossner and Richard Fisher in the US, and Martin Weale and Ian McCafferty in the UK, policymaking becomes more contentious and uncertain.

Unwinding the monetary support

This is scheduled to be the last month for the Fed’s large-scale asset purchases, or quantitative easing. Combined with the skyrocketing volatility (even if the levels are just moving back towards long-term levels), markets are increasingly wondering how the Fed and Bank of England will normalize policy. Both bodies have put out statements of their plans, but markets have not been reassured. The return to normal will be messy regardless of how it is implemented.

Fundamentally, unwinding the policies of the last six years (which some have begun calling the Bernanke or Yellen put) exposes a fundamental difference in the time horizons on which the fed and markets make decisions. Central banks’ mission is to concern themselves with the medium- to long-term growth capacity of the economy.

Markets are concerned about that timeline as well, but are much more short-term oriented than central banks. Investors and their clients are simply not happy to wait for the long-term. They are looking for the edge right now. This has created the perverse situation in which markets react negatively to positive economic news out of the US, since it indicates that monetary policy will tighten sooner.

How Janet Yellen and Mark Carney navigate the uncharted waters of unwinding extraordinary policies and an extraordinary six years will have a great impact on whether these headwinds matter in five years’ time. They have dissent from the public and from some of their colleagues, but they also have the responsibility to stay as apolitical as they can in the implementation of policy. Weighing those two concerns will certainly not be easy.

About Author

Alex Christensen

Alex is an Editor at Global Risk Insights, who also currently works in investment research. His work on political risk and economic policy has appeared in many forums, including Business Insider, Seeking Alpha, Oilprice.com & The Emerging Market Investors Association. He holds a Master’s in Economics from the London School of Economics and BA from Washington University in St. Louis.