The "new normal" of low growth reflects the retardation of monetary stimulus due to the zero bound and the consequent liquidity gap (pushing on a string). Escape from the liquidity gap will require, inter alia, an end to deleveraging and resumption of credit growth. It is beginning to appear that we have turned this corner and that brighter skies are in our future.
The deleveraging phase of the credit cycle has ended, and the cycle has now fully inflected, such that all of the private-sector credit aggregates are growing: households, businesses, financials. This has fully compensated for the decline in public sector credit growth, such that total credit growth is now accelerating on a sustainable trajectory. The growth rate is still very low (3.5%), but it is accelerating and judging by prior recoveries it has a very long way to go (as this graph shows).
Because the financial system intermediates credit, its balance sheet serves as a bellwether for credit conditions. As this graph shows, the financial system has finally stopped shrinking. This is bullish; balance sheet growth would be more bullish.
The most recent credit cycle, which lasted 16 years, began its upswing at the end of 1991 after the Gulf War and continued to accelerate until the subprime bubble burst in 2007. At inception in 1992, credit growth was 5%; by the bubble phase, it was in excess of 10%. Should the current phase follow that trajectory, we could have a decade or more of accelerating credit growth.
The Fed's current policy stance is mildly stimulative as measured by the real funds rate (0%) and the steepness of the yield curve. The end of deleveraging and the resumption of credit growth mean that, for the first time since the Crash, the Fed will have the wind at its back, and policy should regain traction. We can already see this in the recent growth numbers and the stabilization of velocity.
Risk factors to this Goldilocks scenario include deflation, a higher funds rate, and a shock causing a loss of confidence. Falling commodity prices and zero headline inflation suggest that the risk of deflation remains. The control of the FOMC by the hawkish bloc means that the risk of a premature rate hike is very real. The geopolitical situation is rich with potential confidence shocks, with Russia heading the list. I would also observe that the current rate of credit growth is very low and lacking in the margin of safety that would make me feel more comfortable.
Nonetheless, the data suggest that the combination of credit growth plus mild monetary stimulus is likely to deliver good growth for the foreseeable future. Animal spirits are finally returning after a seven-year hiatus.
Low bond yields make equities attractive irrespective of the prospects for earnings growth. The overall outlook for economic growth is favorable, which could support stronger corporate earnings and cashflow. Stocks remain compelling.
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The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am long stocks and bonds.