Artemis' Foster: US set for most extreme contraction ever seen

The US will see 5% wiped off economic growth next year due to the fiscal cliff in January, marking the most extreme fiscal contraction ever seen, said Artemis’s James Foster.

Speaking exclusively to Wealth Manager, the manager of the Artemis Strategic Bond fund said come January the economy would hit a brick wall, as monetary policy would not be able to ‘pick up the slack’.

‘The US is about to go through a 5% decline in GDP through the expenditure cuts and tax increases scheduled for January,’ said Foster.

‘That would be the most extreme fiscal contraction ever undertaken and the economy would hit a brick wall, as monetary policy would not be able to take up the slack,’ he added.

However, US policy remains in limbo until the presidential election is out of the way in November, while markets are left suspended and rely ‘on a steady diet of intervention from the authorities’.

Each time there is an intervention, however, in the form of quantitative easing, Operation Twist or the European long-term refinancing operations, each one has a reduced half-life.

‘The Spanish intervention lasted a whole 10 minutes,’ said Foster. ‘The Operation Twist announced by the Fed had absolutely no effect at all and the market fell.’

Bonds in a bubble

With such a fundamentally weak economic backdrop, government bond yields remain at near-record lows, although Foster believes there is still debate over whether sovereigns are in a bubble.

‘The answer is yes it probably is, but bubbles can last a very long time,’ he said. ‘We own 7% in bunds and gilts, not because we like them but more through a pragmatic attitude while all this uncertainty is going on, and we can understand why people hide in government bonds.’