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Economic Outlook
In our view:
- Growth: Growth will slow noticeably during the second half of the year.
- Inflation: Core inflation measures remain low throughout the year.
- Employment: High unemployment levels persist for the remainder of the year.
- Rates: No Fed rate hikes are likely this year and probably in 2011 as well.
Keith Hembre,
Chief Economist and Investment Strategist
|
Economic, Rates,
and Earnings
Forecast |
2009 |
Keith's
2010
Forecast3 |
2010
Consensus
Forecast4 |
| Real GDP (Q4/Q4) |
0.1% |
2.0 - 3.0% |
3.2% |
| Unemployment Rate1 |
10.0% |
10.0% |
9.5% |
| Consumer Price Index1 |
2.7% |
0.7% - 1.7% |
1.8% |
| 10-Year Treasury Yield1 |
3.8% |
2.8% - 3.8% |
3.7%5 |
| Corporate Earnings2 |
$56.86 |
$76.00 |
$81.736 |
|
1End-of-period level; 2S&P 500 operating earnings; 3As of July 2, 2010; 4Blue Chip economic indicators, June 10, 2010; 5Average yearly level; 6S&P bottom-up consensus, June 22, 2010
— July 2010
Past performance does not guarantee future results.
Federal Funds Rate: Set by the Federal Reserve Board, the Federal Funds Rate (Fed Funds Rate) is the interest rate charged by banks with excess reserves at a Federal Reserve district bank to banks needing overnight loans to meet reserve requirements. The Fed Funds Rate is considered a sensitive indicator of general interest rate trends.
S&P 500: The unmanaged S&P 500 Index tracks the performance of 500 U.S. large-company stocks.
Operating Earnings: Operating earnings are company profits after subtracting from revenue expenses such as cost of goods sold, administration, marketing, and general operating costs.
Economic Update
Keith Hembre discusses his economic outlook
June 11, 2010
What's your economic outlook for the rest of the year?
I believe growth will slow from the 3% range to approximately 1 to 2% per quarter in the second half of 2010. This will mainly be a result of the fading impact of the fiscal stimulus package, as well as the reduced impact of inventory rebuilding, which contributed to growth in 4Q-09 and 1Q-10.
Will there be a double-dip recession?
I do not think a double-dip scenario is likely. The following three indicators typically predict a recession, and we've observed none of them at this time:
1. No yield-curve inversion (where long-term rates are lower than short-term rates).
2. The yield curve remains historically steep. No Fed rate increases.
3. Fed action is unlikely to occur before the end of the year or through the first half of 2011. The Index
of Leading Economic Indicators is still positive.
What will be the economic impact of the Gulf oil spill?
The oil spill will not have a significant short-term impact on gross domestic product (GDP) because the industries involved (oil workers, shipping and fishing) are not a meaningful component of the U.S. GDP. In the longer term, the likely drilling restrictions and new industry regulations will increase the cost structure of the industry, leading to less domestic oil production and higher prices. Still, only about 4% of U.S. consumption is spent on energy, so even a large price increase will be only negative at the margin for the U.S. GDP.
Should we be concerned about the large amount of U.S. Treasury debt?
Yes, I believe the amount of debt is a significant issue, but the solution is unclear because it requires a political response. Recent flow-of-funds data from the Fed indicated that the Treasury is the only credit segment showing growth (household credit, mortgage debt, private business borrowing, and financial system credit were all down). In terms of total U.S. debt outstanding, we are at the highest level since the 1930s. Current deficit spending is at 10% of GDP.
The problem is that there is no easy fix. Cutting spending or increasing taxes would have an economic impact at a time when there is political pressure to continue fiscal stimulus. Still, some political groups argue that current spending is not sustainable and have been advocating for deficit reduction. The approaching November elections are a complicating factor, as politicians are likely to focus more on economic and job-growth issues again.
Will the Fed raise rates?
We do not believe the Fed will raise rates this year, and there may be no rate increases through the first half of 2011, depending on economic data. The Fed has two directives: maintain full employment and keep prices stable. Currently, there is no urgency to normalize because we are nowhere near full employment (unemployment remains near 10%), and inflation is not a concern. (Inflation measures are at the low end of the Fed's tolerance range.)
What will be the impact of the European turmoil?
Overall, I believe the European situation will have only a modestly negative impact on world and U.S. growth. The policy response to the European debt crisis has been to create a special-purpose lending vehicle with capital and guarantees supplied by core Europe. In addition, the European Central Bank has been buying bonds to stabilize markets until the program is up and running. These actions stabilize market conditions and alleviate the short-term funding crisis faced by nations like Greece, but they do not solve the long-term concerns about default. Part of this package was a requirement that the weaker countries adopt austerity measures, which will create weaker economic growth in these nations. An offsetting factor is that the falling euro has created cheaper exports. Germany, the world's second largest exporter (behind China), is likely to benefit from the lower euro. We believe the situation will have a modestly negative impact on the global economy overall. The United States will be negatively affected at the margin as exports to Europe fall and the rise of the dollar makes U.S. exports generally less competitive worldwide.
How will the proposed and potential increased regulation of the healthcare, financial and energy industries affect growth?
While these issues make headlines, they have much less potential impact on the economy than broader issues, such as increasing the Fed funds rates. Besides, the regulation does not change the cyclical performance dynamics of these sectors. Each sector will feel some economic impact but not great enough to derail economic recovery. For example, the potential healthcare reforms provide disincentives for small businesses to hire because they create uncertainty about the costs of new hires. In the financial sector, the potential bank tax would reduce performance of these stocks one time, but then normal growth trends would resume. New regulation in the oil industry would increase the cost structure and cause the cost of energy to rise, but energy is a small percentage of overall consumer expenditure in the United States.
What is the outlook for employment?
Employment tends to follow GDP and corporate profit trends with a two- to three-quarter lag. If the economy slows in the second half of 2010, as we predict, this implies slower improvement in employment. In addition, the temporary census-worker hiring will reverse. The longer-term legacy of this period of high unemployment will be its dampening effect on wages in the years to come.
Index of Leading Economic Indicators: An index tracking a number of economic indicators considered to be leading. A leading indicator is one that occurs before an economy has started moving in a particular direction. For example, a reduction in the average number of hours worked by manufacturing employees is considered a leading indicator because it usually precedes an economic slowdown or a recession.
