Reducing the uncertainty premium

From my friend David Kotok

The Evolving Policy Landscape
December 13, 2013

The evolving policy landscape in the United States is reducing the uncertainty premium. That is bullish for US financial markets and its economy and outlook.

A troika of Fed (Federal Reserve) officials, including Bank of New York President Bill Dudley, Fed Vice Chair Stanley Fischer, and Fed Chair Janet Yellen, will lead policy in 2014 and 2015. That is the period of time in which the Fed will transition from $85-billion-per-month quantitative easing to a gradual extraction and approach to neutrality. We expect the Fed’s communication strategy to improve, its policy to become more consistent, and the application of same to become more transparent. The Fed’s new leadership lineup represents an excellent evolution.

For the first time in recent years in Washington, DC, lunacy has given way to a baby step back towards sanity. We have a budget deal, albeit a small one. We have a deferral of shutdowns and shocks for at least a year or two. The Speaker of the House of Representatives, John Boehner, is re-emerging with new strength and is in control of his caucus. There is isolation of the extremists on the right, and less so on the left. We have a deficit forecast of less than 3% of GDP and falling.

The rate of inflation in the US is below 2% and falling. By some measures it is 1% and falling. The outlook for inflationary shocks continues to diminish. This is positive for bonds and borrowers and constructive with regard to transparency and the accurate reporting of earnings, profits, and sales. Less inflation means more accurate numbers and fewer distortions.

Lastly, gradual improvement in the labor markets is underway. It is slow. There are soft spots. The trend, though, continues to be positive.

We approach 2014 with a rather magical if unexpected combination of positive policy, financial, and economic forces. Next year will start as a very good year. After that, as with anything else, it all remains to be seen.

David R. Kotok, Chairman and Chief Investment Officer

Resources:
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