The US has generated a slew of disappointing economic data over the course of the first quarter.
Despite the fillip from lower oil prices, retail spending has been weak and wage inflation remains anaemic.
The Federal Reserve Bank of Atlanta’s new GDPNow indicator suggests the US grew at a paltry 0.1 per cent in the first quarter of 2015. This is substantially lower than the 3 per cent consensus earlier this year and highlights the extent to which the economy has slowed in recent months.
However, the Federal Reserve appears convinced the growth and inflation dynamics within the US economy remain cyclical in nature and further improvement in the employment market will generate higher inflation.
Moreover, the data monitored by the central bank may well improve significantly over the second quarter as improving weather helps foster a rebound from the weaker start to the year – a temporary phenomenon that could easily be misinterpreted.
This is dangerous as it encourages tighter monetary policy in a country that may remain structurally impaired and extremely sensitive to changing conditions.
High debt levels have engendered fragility in the behaviour of consumers and businesses, suppressing spending levels and making their activities unusually sensitive to small changes in economic conditions.
In this context, there is a significant risk higher rates will prove to be a policy error and generate a recessionary environment. This would clearly be a very negative outcome for equities and growth-related assets.
However, even allowing for the headwinds, there are also reasons to be more optimistic on the outlook.
Not only does the US employment market continue to improve significantly but it is far from certain that a US rate rise would have the poor outcome outlined earlier.
One theory suggests emergency monetary policy is in itself undermining business confidence and that investment would pick up with interest rates.
Even if this sounds far-fetched, it is still possible the currency response to higher rates could help the US transition to sustainable growth. Traditional interest rate differential analysis argues higher rates would support the dollar.
Its strength in recent months has been an impediment to the US economy and further appreciation would add to the recessionary forces, outlined previously.
However, we are intrigued by a cyclical relationship that usually sees the first rate hike accompanied by a weakening of the dollar. Should this be replicated, it would offer significant support to economic growth even as monetary policy is tightened with positive results characterised by a growth surge, rising equity markets and a prolonged bond sell-off.
Our key message is that 2015 is a year in which the Fed will try to wean itself off emergency policies, with a wide range of potential outcomes spanning recession to a sustainable lift-off in economic growth.
This is likely to result in a very painful year for many managers. The positive and negative scenarios may well each appear correct at different times as the year unfolds.