Rising Asset Prices Sharpen US Policy Challenge

As the housing market wakes up and the stock market rallies, strong gains in asset prices are improving US household wealth and helping to reduce the federal deficit. This is a great boost for confidence, but it also sharpens the challenge facing US fiscal and monetary authorities.

Rising prices of real and financial assets (display) are a catalyst for spending because they increase household wealth and create fiscal benefits, which fuel economic growth. Indeed, private sector gross domestic product (GDP) advanced at an annualized pace of 4% in the first quarter, while private sector job growth has averaged over 200,000 for the past seven months.

Stocks and Real Estate Rebound

In early May, both the Dow Jones Industrial Average and the S&P 500 Index reached record highs, each rallying nearly 16% since the start of the year. Equity-price gains have added approximately $3 trillion to US household total net worth.

Real asset prices have also increased by more than 3% through April. With real estate values at $20 trillion, the additional increase in real asset values would add $600 to $800 billion to household net worth so far this year, pushing it far into record territory. Against this backdrop, it’s no coincidence that real consumer spending rose by 3.2% annualized in the first quarter, the biggest quarterly gain in more than two years.

Fiscal Deficits Are Narrowing

The US Treasury is also enjoying the asset-price ride. The Congressional Budget Office (CBO) has pegged the 2013 deficit at $642 billion, or $203 billion below its estimates from earlier this year. It now projects the federal deficit will decline from 4% of GDP in 2013 to 2.1% in fiscal year 2015, the smallest deficit since 2007.

Federal revenue has enjoyed a boost from an announced dividend payment of $95 billion to the US treasury by Fannie Mae and Freddie Mac, which is tied to a recovery in real estate prices. And the CBO says individual tax receipts are nearly $70 billion higher than estimated a few months ago, apparently because of rising capital gains and higher personal income growth. All told, the downward revision to the current budget deficit is one of the largest on record. State governments are also benefiting from a revenue windfall.

Of course, in the past we’ve seen that rising asset prices can also breed spending imbalances, irrational expectations and complacency. In the 1990s, the US economy was fueled by an equity-market boom, and in the 2000s, growth before the financial crisis was buoyed largely by a real estate bubble.

In a more buoyant environment, monetary policymakers may be reluctant to withdraw a loose monetary policy soon enough. The sharp reduction in budget deficits might compel fiscal policymakers to defer decisions on long-term budget imbalances.

Changes Are Easier in Solid Environment

We think that would be a mistake. In our view, growing concern about financial stability should lead the Fed to consider tapering its asset purchase program soon. We also believe that budget discussions should take place because it is always easier politically to make small changes in a positive growth environment than to make big changes during a downturn.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Joseph G. Carson

Director—Global Economic Research
Joseph G. Carson joined the firm in 2001. He oversees the Economic Analysis team for Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor’s All-Star Team for Fixed Income. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees. He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Location: New York

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