US Savers Turned the Screw in 1Q

• US Cyclical Factors including ROC and Real Labour Productivity Remain Sharply Positive
• But Deleveraging Accelerated Again in 1Q, Pushing Up Private Sector Savings Surplus , and and Pushing Down Loan / Deposit Ratios
• Renewed deleveraging is anomalous, and is not reflected in asset prices or straightforward risk measurements
• Renewed deleveraging is anomalous at a time of exceptionally bad bond-market value
• So the Growth Risk for the Rest of the Year Remains on the Upside

We now have quarterly GDP numbers for the world's major economies, so it's time to start tracking movements in the fundamental ratios which structure the world's business cycles, starting with the US.

Our view based on these ratios for 4Q11 were (in this piece)as follows: “. . . by our estimate returns on capital are around their highest since 2000 and are still rising, which will continue to foster investment spending; labour productivity continues to grow (adjusted for changes in capital stock), which will underpin the slowly- accelerating addition of jobs; and, most importantly, we believe that the net develeraging of the economy which started in 2008 is now complete. We do not expect significant re-leveraging to take place this year, but the mere fact that deleveraging is no longer the key dynamic will shift the economy out of its modest 2.4% annualized growth trend which it has sustained since the end of the recession in 2009 and towards a 3%+ rate.”

How much of that is still right? The good news is that returns on both capital and labour continue to rise, at an accelerating pace – the best underlying news for a sustained business cycle upswing.

ROC is still climbing, and this continues to fire major capital investment spending: in nominal terms, total fixed capital investment jumped at an annualized pace of 20.8% during 1Q. In real terms, private capital spending rose only a miserable 1.4% annualized - but there seems to be an unaccounted seasonal factor at work depressing the 1Q investment numbers, since this was the best 1Q reading since 2006. Overall, nominal capital stock is probably growing around 1.2% a year – still less than half the c4% yoy nominal GDP growth, so we should expect ROCs to continue to rise along with asset turns.

Real output per worker, adjusted for capital stock per worker, also accelerated mildly to 3% during 1Q, an inflection from from 2.8% in 4Q10 which should be enough to sustain improvements in the labour market. 

As far as margins are concerned, the US international terms of trade have held steady since they bottomed out in December 2011: since then export prices have risen 2%, whilst import prices have risen just 1%.

All of this suggests the US cycle should be in buoyant good health. But it doesn't seem to be: the 2.2% annualized GDP growth recorded in 1Q was lower than I expected, and a retreat from the 3% of 4Q11. And there's probably more on the way, since the GDP data disappointed even before the 'soft patch' began to show up in the data for April and May's economy.

I have previously explained the origins of that 'soft patch' in the industrial sector, using changes in momentum of output, domestic demand, inventory and export demand. I think that analysis is both correct and useful . . . . but also incomplete.

For the big disappointment of 1Q is that deleveraging had not stopped, as I expected. Rather, it re-started and re-intensified – and it is that which so far is the decisive factor in the US recovery. One can capture this by two counts. First, the private sector savings surplus jumped to 8% of GDP in 1Q from 5.2% in 4Q11. There are strong seasonal factors at work, but nevertheless, that jump was sufficient to push up the 12m ratio to 4.7% of GDP, from 3.8% during calendar 2011. This is the only quarter since 2009 that the PSSS has risen significantly. 

Second, the same story is written in the banking system's balance sheet: during 4Q11 banks' loan to deposit ratio stood at 81.8%, and was rising gently, having seemingly bottomed out in 3Q11. But by early May 2011, the ratio had fallen again, to 80.8%, with deposits rising US$153bn since the beginning of the year, compared to a rise of only US$70bn for loans. 

Awaiting Eurogeddon, it may seem obvious that caution must reassert itself. But, of course, the timing doesn't fit. More, reawakened caution was not obviously reflected – and frankly, still is not obviously reflected – in US financial asset prices. During 1Q, most measurements of risk were in retreat: 5y bank CDS rates declined to average 201bps in 1Q12 from 252bps in 4Q11, whilst the capital risk premium on 10yr Treasuries (spread between 10yrs and 10yr TIPs) widened modestly in a way which usually signals improving risk tolerance.

More, US Treasuries became ever more expensive relative to the fair value you would expect in an economy growing 2.2%, CPI inflation of 2.82% and a Fed Funds target of 25bps. Historically, as the chart below shows, when Treasuries represent such astoundingly bad value, one expects Private Sector Savings Surpluses to start to dwindle. But rather, the opposite happened.

In conclusion, we really do not know what has provoked re-invigorated deleveraging in the US during 1Q12 - for the time being it remains anomalous. Unless or until a workable explanation is found, we should expect precisely that it will be an anomaly, which is likely to be corrected in the coming quarters. If so, the upside risks to US growth during the rest of 2012 continue to look greater than the downside risks.