Christine Lagarde of the IMF sees a 3-speed economy (Part 2)

Market Realist

Continued from Part 1

Countries that were hurt during the crisis but are now recovering

This is the second of Lagarde’s three economic groups.

United States

The United States has taken a strong monetary policy stance to take the crisis by the horns through keeping interest rates artificially low at any cost. The cost ended up at $80 billion per month (a 50-50 split between long-term Treasuries and mortgage-backed securities), which has inflated the Federal Reserve’s balance sheet to unprecedented levels.

While the government has been able to reduce its fiscal deficit significantly, there’s a long way to go. Healthcare programs and medicare continue to balloon with no solid plans to address them and the sequester [1. Automatic sequestration of several budget items, including key healthcare and education programs since politicians didn’t reach an agreement was a terrible short-term fix due to the gridlock in Washington.

Lagarde stated that the United States isn’t doing as well as it could, mainly due to “self-inflicted fiscal wounds,” with the sequester being one of the main problems. In her opinion, the country needs a credible medium-term plan that addresses how to increase fiscal revenues and reduce spending, minimizing the effect on growth.

The recent statements by the U.S. Fed regarding a potential ramp-down of the bond buying program shot an arrow at the knee of the capital markets, causing a massive repricing of debt and significantly hindering the availability of corporate credit. The market seemed to have ignored the fact that the tapering would occur only if unemployment dropped below 6.5% and inflation roses above 2% (to avoid a Japan in the ’90s scenario). At the current rate, this may happen well into 2014, but still, the market has priced in a Q3 ramp-down.

(Read more: How investing in emerging markets differs from developed markets)

Other developed countries

Countries like Australia (EWA) and Canada (EWC) have commodity driven-economies and are partially tied to global commodity prices as well as demand from their closest neighbors.

Canada (EWC) naturally depends partially on the health of the U.S. economy, so the Canadian economy should improve once the U.S. economy picks up. This should match an acceleration of commodity prices as demand increases with worldwide recovery.

Australia (EWA) is in a similar boat, though with China (FXI). Given that the United States is starting to recover while China is currently deteriorating, Australia’s economy may take slightly longer to pick up. Nonetheless, it will also benefit from recovering commodity prices as long as China’s dent isn’t too deep.

(Read more: Why recession in Brazil is not imminent, but the short term will hurt)

The third group

Continue to Part 3

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