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Economic and Market Review

By: Ryan McCarroll
Risk Analyst


 

Nearly two years after Standard and Poor’s lowered its U.S. credit rating to AA+, the company has raised its outlook from “negative” to “stable.” One reason for the improvement in outlook has been a reduction in the budget deficit. According to the Treasury Department, the budget deficit for the fiscal year starting October 2012 is down 26% from a year ago. The smaller budget deficit is not due to a decrease in outlays, but an increase in revenue. According to the Congressional Budget Office, the full fiscal year deficit is expected to fall to $642 billion; the budget deficit has not been below $1 trillion since 2008. While a smaller budget deficit is an encouraging sign, some market participants are concerned that easing fiscal conditions will reduce pressure on law makers to make long term structural spending reforms.

Consumer confidence hit its highest level in over five years according to the University of Michigan consumer sentiment index. A major contributor to increased optimism is the wealth effect from sustained increases in housing and equity prices. The increase in optimism translated into a stronger than expected 0.6% month over month increase advanced retail sales for May. A confident consumer is an encouraging sign as consumer spending typically accounts for approximately 70% of GDP.

The labor market increased payrolls during May on par with levels seen recently. The 175 thousand gain in non-farm payrolls did not result in a great deal of optimism or concern regarding the near term trend in the labor market. The unemployment rate increased one tenth of a percent to 7.6%. This increase is not overly disappointing however, as the increase was due to a return of discouraged workers to the labor force.

The timing at which the Federal Reserve will begin “tapering” its bond purchasing program has come under increased scrutiny as of late. This speculation has cause increased volatility in the bond and equity markets. The Fed reiterated in its April FOMC minutes that it was “data dependent” and would not reduce its bond purchases until conditions improve sufficiently. This suggests that fears are exaggerated, as tapering would likely coincide with stronger employment and mark the beginning of a return to a normalized monetary environment, both positive signs for the economy.



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