April 30, 2012

The first quarter of 2012 brought a welcome surge in global equity markets, giving investors hope that the lingering effects of the recession that ended officially in 2009 might finally be waning. The Federal Reserve reiterated its expectation that inflation would remain under control at least through 2014, yet acknowledged that recent improvements in the economic outlook could make a third round of quantitative easing unnecessary. Europe, meanwhile, performed first aid on its sovereign debt issues, lowering interest rates and infusing capital into the European banking system. Overall, caution is still the operative word; however, good news on the jobs front and rising consumer spending are beginning to bring optimism into the conversation as well.

Concerns about Europe’s debt crisis and the health of the U.S. recovery were swiftly addressed in the first quarter, easing immediate fears and helping fuel the stock market surge. The Fed’s commitment to keep interest rates low and the European Central Bank’s show of support for Europe’s banking system were positive factors. The U.S. savings rate increased slightly to 4.5% as companies and individual investors continued to reduce debt levels and real disposable income edged up 1.4%. And although foreclosures kept housing prices relatively soft and continued credit restrictions dampened buyers’ enthusiasm, the real estate market showed some tentative improvement. Following increases in GDP growth, consumer spending, and car sales in the fourth quarter of 2011, a mood of cautious optimism about prospects for 2012 has begun to spread.

Driven by consumer spending, rising exports, and non-residential fixed investment, real gross domestic product, the widest gauge of U.S. economic strength, increased at an annual rate of 3% during last year’s fourth quarter according to the latest update of government statistics. That’s almost double the 1.8% third quarter rate and the 1.7% rate for 2011 as a whole. Although the Fed has predicted that growth will have slowed to 2% in the first quarter—and that high oil and gas prices may indeed temporarily increase the inflation rate—further gains may come later in the year as the unemployment rate continues a slow decline.

The job market continued to improve during the first quarter, though the strong employment gains that occurred in December, January, and February did not continue into March, when just 120,000 jobs were added, well short of the predicted 205,000. As a result, the unemployment rate declined a mere 0.3% to 8.2%. New positions were created in manufacturing, food services and bars, and healthcare, while retail jobs lagged and federal employment was flat. 

Though sticker shock at the gas pump makes it feel as though consumer prices have been surging, there’s little indication that overall inflation is staging a comeback. Consumer spending is rising, helped by wages that rose 3.1% through the 12 months that ended in February, and that could begin to put upward pressure on prices. Yet the Fed continues to predict inflation will be contained, and despite a 0.4% rise in the Consumer Price Index in February, annual inflation remained at a moderate 2.2%.

Going forward, much depends on Europe, which is likely already in a recession. A smaller-than-expected retreat there could help global markets, while a harsher downturn could have the opposite effect. Meanwhile, everyone is waiting to see whether the recent positive signs in the U.S. economy will result in measurable improvements in GDP growth without also increasing inflationary pressures. Stagnant U.S. corporate earnings could be a problem, as could any slowdown in China. Yet all in all, it seems reasonable to hope that the U.S. recovery will continue to gain ground as the year unfolds.