The Economic Outlook for
2010Presented to:
Houston Economics ClubFebruary 18, 2010
Harvey Rosenblum Executive Vice President &
Director of Research
Jessica RenierSenior Economic Analyst
Federal Reserve Bank of Dallas The views expressed in this presentation are strictly those of the authors and do not necessarily reflect the positions of the Federal Reserve Bank of Dallas or of the Federal Reserve System.
Economic Model: Recessions
Guitar-string theory:Deeper recessions are
followed by stronger, more rapid recoveries.
- Milton Friedman
Economic Model: Financial Crises
“The aftermath of deep financial crises shows deep and lasting effects on asset prices, output and employment. Unemployment and house price declines extend out for five and six years. Output declines last two years on average. Even recessions sparked by financial crises do eventually end, albeit almost invariably accompanied by massive increases in government debt.”
- Reinhart and Rogoff (Dec. ‘08)
Summary Forecasts for 2010
• GDP: 2-3%, more likely close to 3%– Absent the financial crisis: 5-6%
• Headline inflation: 3.0%• Core inflation: 1.5%• Unemployment:
– 10.4% peak in 2010 Q2– Sustained employment growth to begin
Feb. 2010
But This Time is a Combination
This recession was…• Most painful since the Depression
– Longest, Deep and Wide• Followed 25 years of growth
interrupted by two short, mild recessions
Bottom Line:• Relative to a generation of
experience, this was a truly traumatic event.
Behavior Modification
Only traumatic events, not hiccups,
produce behavior modification.
Global Backdrop
IMF World Economic Outlook:What a Difference a Year Makes
2005 2006 2007 2008-2-10123456% annual rate
IMF
HR
3.0
0.2
2009
One Year Ago: 2009 Forecast
Source: IMF World Economic Outlook, Oct. ’08/’09
IMF World Economic Outlook:What a Difference a Year Makes
2005 2006 2007 2008-2-10123456% annual rate
IMF
HR
3.0
0.2
2009 2005 2006 2007 2008 2009-2-10123456
-1.1
% annual rate
2009
One Year Ago: 2009 Forecast Current: 2010 Forecast
Source: IMF World Economic Outlook, Oct. ’08/’09
IMF World Economic Outlook:What a Difference a Year Makes
2005 2006 2007 2008-2-10123456% annual rate
IMF
HR
3.0
0.2
2009 2005 2006 2007 2008 2009-2-10123456
-1.1
3.1
% annual rate
IMF HR3.0
20102009
One Year Ago: 2009 Forecast Current: 2010 Forecast
Source: IMF World Economic Outlook, Oct. ’08/’09
Purchasing Managers’ Indexes of Manufacturing Activity
U.S. U.K. Germany Euro Zone Japan China30
35
40
45
50
55
60Index
Dec ‘09
Nov ‘09
Mar ‘09
Expand
Con-tract
Jan ‘10
Source: Institute for Supply Management, Bloomberg
G10 Industrial Production(excluding construction)
'00 '01 '02 '03 '04 '05 '06 '07 '08 '0970
75
80
85
90
95
100
105
110
115Index, 2000=100
U.S.
Source: Federal Reserve Board
G10 Industrial Production(excluding construction)
'00 '01 '02 '03 '04 '05 '06 '07 '08 '0970
75
80
85
90
95
100
105
110
115Index, 2000=100
U.S.
U.K.
E.U.
Japan
Source: Federal Reserve Board, UK Office for National Statistics, Statistical Office of the European Communities, Japanese Ministry of Economy, Trade & Industry
U.S. Economy
Elements of Trauma
• High unemployment• Actual deflation• Negative wealth shock
– Bursting of multiple bubbles• Synchronized global shocks• Near-demise of banking/financial
system
Going Forward…Headwinds• Credit to households
and small businesses• Banking system –
capital, CRE losses• Anticipated taxes• Policy uncertainty• Higher energy prices
Tailwinds• Emerging Market
economies• Inventories• Labor availability• Idle plants• Lagged impact of
global stimulus• Equity market
rebound and anticipated profit growth
• Improving capital markets – lower credit spreads, stronger risk appetite
Crosswinds• Monetary policy• Fiscal policy• Regulatory policy
Positive Momentum• Growth in temp employment• Declining initial unemployment claims• Declining layoff announcements• Nearly 40% of industries adding
workers, vs. 80% of industries cutting employment a year ago
• Synchronized global recovery• Capex
– Rig count and Semi equipment orders• Industrial production bounce-back
GDP and Inflation
Real GDP Growth
2007
2008
2009
-8
-6
-4
-2
0
2
4
6
8SAAR, % change
5.7%
Low-to-Moderate Inflation
2007
2008
2009
-3
-2
-1
0
1
2
3
4
5
6% Yr/yr
Headline CPI
Core CPI
Trimmed Mean PCE
Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Dallas Fed
Why were we so wrong about year-end inflation?
• Given fears of deflation at year-end 2008, we thought a 1% deflation over 2009 was the most likely outcome.
• We averted that outcome, and that’s a prediction we’re very happy to have been wrong about.
• Credit Chairman Bernanke and the FOMC
Job Market Simply Awful, But Poised to Turn as Temp Leads Gains
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10-200
-150
-100
-50
0
50
100
-800
-600
-400
-200
0
200
400Change, thousands
Temp employment
Source: Bureau of Labor Statistics
Job Market Simply Awful, But Poised to Turn as Temp Leads Gains
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10-200
-150
-100
-50
0
50
100
-800
-600
-400
-200
0
200
400Change, thousands
Payroll employment
-20k
-150k
+64k
Temp employment
Change, thousands
Source: Bureau of Labor Statistics
Benchmark added 930k lossesTotal jobs lost: 8.4 million
• Level of employment is lowest since Sep. 1999
• Private sector job level similar to Nov. 1998
• Unemployment fell to 9.7%– Likely to rise again once people re-enter
labor force • Initial jobless claims have declined,
more needed• Wages, hours worked and productivity
increasing
Bottom Line: Existing workers being pushed harder
Labor Market: A Mixed Bag,
But Fixin’ to Improve
A Look At Housing
GDP Inventories Consumption Nonres. Invest.
Res. Invest. Net Exports Government-1
0
1
2
3
4
5
6 5.7
3.4
1.4
0.30.1
0.5
0.0
Percentage Points
Contributions to Real GDP Growth(Advance Release: Q4 2009)
Source: Bureau of Economic Analysis
Ex. Equipment & Software: -0.5
GDP Inventories Consumption Nonres. Invest.
Res. Invest. Net Exports Government-1
0
1
2
3
4
5
6 5.7
3.4
1.4
0.30.1
0.5
0.0
Percentage Points
0.8
-0.5
Equipment & Software
Commercial Real Estate
Contributions to Real GDP Growth(Advance Release: Q4 2009)
Source: Bureau of Economic Analysis
U.S. House Price Index (Case-Shiller)
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09-3.0-2.5-2.0-1.5-1.0-0.50.00.51.01.52.0
Percent change
Source: S&P, Fiserv, MacroMarkets LLC Note: Composite 10-City Index
Nov0.2%
Jan-2.1%
U.S. Housing Affordability Index
'71 '73 '75 '77 '79 '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '0960
80
100
120
140
160
180Index
Source: National Association of Realtors
Dec164
Mortgage Rates
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-104.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
Jumbo6.1
30-year5.3
4.8
15-year
Source: Bloomberg, Bankrate.com
Percent
Home Sales Noisy
'06
'07
'08
'09
3500
4000
4500
5000
5500
6000
6500
200300400500600700800900100011001200
Thousands Thousands
New 1-family homes
Existing 1-family homes
Permits & Starts Sideways
'06
'07
'08
'09
200
400600
8001000
12001400
160018002000
Thousands
1-Family per-mits
1-Family starts
Source: Census Bureau, National Association of Realtors
Home Inventories Lower…
'06
'07
'08
'09
456789
10111213
Months’ supply
New 1-family homes
Existing 1-family homes
But Foreclosures Climbing.
'06 '07 '08 '090
1
2
3
4
5Percent
Foreclosure inventory
Foreclosures started
4.5
1.4
Source: Census Bureau, National Association of Realtors, Mortgage Bankers Association
The Consumer
1.4
1.2
1.0
0.8
1980 1985 1990 1995 2000 2005 2010
1.4
1.2
1.0
0.8
50
40
30
50
40
30
HOUSEHOLD DEBT-TO-INCOME RATIOTREND LINE
BANK LOANS AS % OF GDPTREND LINE% %
The Credit Overshoot Has Not Been Unwound
Source: BCA Research 2010, Martin Barnes
Annual Consumption Growth Rate
1930
1934
1938
1942
1946
1950
1954
1958
1962
1966
1970
1974
1978
1982
1986
1990
1994
1998
2002
2006
2010
exp
-15
-10
-5
0
5
10
15Percent, yr/yr
2010Forecast
2.2%
Source: Bureau of Economic Analysis
Household Wealth
'90 '92 '94 '96 '98 '00 '02 '04 '06 '08300
350
400
450
500
550
600
650Percent of disposable personal income
Household net worth
Household finan-cial assets
Peak-to-trough declinesNet worth: $17.5 trillionFinancials: $11.2 trillion
486
404
Personal Saving Rate Climbing
'90 '92 '94 '96 '98 '00 '02 '04 '06 '080
1
2
3
4
5
6
7
8
9
10
4.6%
Percent, 3MMA
Source: Bureau of Economic Analysis
Investment Spending
Business Spending Recovers Slowly Following Recessions
'81 '84 '87 '90 '93 '96 '99 '02 '05 '08-25-20-15-10-505
10152025
Yr/yr %, private fixed investment (nominal)
Sep. 11
Housing bubble
Source: Bureau of Economic Analysis, Wall Street Journal
U.S. Oil and Gas Rig Counts Rising
'94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '090
200
400
600
800
1000
1200
1400
1600Rig Count
Gas Rig Count
Oil Rig Count
Source: Baker Hughes, Inc.
Capacity Utilization Still Very Low…
'90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '0965
70
75
80
85
90
60
70
80
90
100
110
120
72.0%
Total Industry Capacity Utilization
SA, Percent of Capacity
25yr average: 80.3%
Source: Federal Reserve Board
…But Industrial Production Improving
'90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '0965
70
75
80
85
90
60
70
80
90
100
110
120
72.0%
100.3
Industrial Production
Total Industry Capacity Utilization
Index, 2002=100SA, Percent of Capacity
Source: Federal Reserve Board
Manufacturing Orders Up Sharply
123456789101112131415161718192021222324252627282930313233343536373839404142434445464748495051525354555657585960616263646566676869707172737475767778798081828384858687888990919293949596979899100101102103104105106107108109110111112113114115116117118119120121122123124125126127128129130131132133134135136137138139140141142143144145146147148149150151152153154155156157202530354045505560657075
50+ = Expanding
ISM New orders
Source: Institute for Supply Management
Manufacturing Exports Expanding Reasonably Well
123456789101112131415161718192021222324252627282930313233343536373839404142434445464748495051525354555657585960616263646566676869707172737475767778798081828384858687888990919293949596979899100101102103104105106107108109110111112113114115116117118119120121122123124125126127128129130131132133134135136137138139140141142143144145146147148149150151152153154155156157202530354045505560657075
50+ = Expanding
ISM New export orders
Source: Institute for Supply Management
Financial Markets
Interbank Frictions Mostly Gone
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-100.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0Percent
3M LIBOR – Expected Fed Funds
Source: Financial Times, Reuters
0.12
A Tale of Two Credit Markets
Junk Bond Spread
2007
2007
2007
2008
2008
2008
2009
2009
2009
0
4
8
12
16
20
24Percent
Junk-7yr Treasury
Junk-AA
Interest rates charged on credit
cards up to 29.99%
Source: Merrill Lynch, Federal Reserve Board, Moody’s
The Wind Is Beginning To Shift Direction
Banks Close to Beginning an Easing of Credit Standards
'96
'97
'98
'99
'00
'01
'02
'03
'04
'05
'06
'07
'08
'09
'10
-40
-20
0
20
40
60
80
100Percent tightening standards
Commercial loans(large and medium firms)
Consumer loans
Source: Senior Loan Officer Opinion Survey on Bank Lending Practices (Federal Reserve Board)
Long-Term Willingness of Banks to Make Consumer Loans is Increasing
'70 '75 '80 '85 '90 '95 '00 '05 '10-80
-60
-40
-20
0
20
40
60
80Percent
Net Percentage of Banks More Willing to Make Consumer Installment Loans
more willing
less willing
9.6%
Source: Senior Loan Officer Opinion Survey on Bank Lending Practices (Federal Reserve Board)
The Number of “Problem” Institutions on the FDIC’s List
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q30
100
200
300
400
500
600
53 61 65 76 90117
171
252305
416
552
$346B
2007 2008 2009
Number of banks, or$ Billions
Assets of problem banks
Source: FDIC
Monetary Policy
Rosenblum’s First Law
For every Federal Reserve policy action, there is an equal and
opposite criticism.
Fed Balance Sheet Outstanding:Economy Still on Life Support
Sep. 3, 2008 Dec. 31, 2008 Mar. 25, 2009 Jan. 6, 2010200
450
700
950
1200
1450
1700
1950
2200
2450Billions $
Week ended:
$1,020
$2,426
$2,144 $2,216
$2,247$2,051
$2,199
$894
Fed AgencyFed Agency
Fed Agency
MBS
MBSTreasurys
Treasurys
Treasurys
Treasurys
TSLF
TSLF
TSLFTSLF
Special Credit Facil-
itiesSpecial
Credit Facil-ities
Special Credit Facili-
tiesSpecial
Credit Facili-ties
Source: Federal Reserve Board
FOMC Central Tendency Projections(average of tendency range)
Real GDP2.7
2.9
3.1
3.3
3.5
3.7
3.9
4.1
4.3Percent
Unemploy...5
6
7
8
9
10Percent
PCE inflation1.3
1.4
1.5
1.6
1.7Percent
Core PCE1.20
1.25
1.30
1.35
1.40Percent
Source: Federal Reserve Board
2010 2011 2012
30
20
10 0
2000 2002 2004 2006 2008 2010
3020
10 0
3.0
2.5
2.0
1.5
3.0
2.5
2.0
1.5
NFIB PLANNED PRICE HIKES
% %
TRIMMED MEAN PERSONAL CONSUMPTION EXPENDITURES INFLATION RATE% %
Inflation is Muted Due to Lots of Excess Capacity
Source: Dallas Fed, NFIB and BCA Research
Inflation Expectations Still Moving Up?
2003
2004
2005
2006
2007
2008
2009
2010
-1.5-1.0-0.50.00.51.01.52.02.53.03.5
2.42.1
SA, Percent
10-year TIPS inflation expectations
5-year TIPS inflation expecta-tions
Source: Federal Reserve Board
• Drop phrase “likely warrant exceptionally low rates for an extended period.”
• Allow special liquidity facilities to expire – Most will expire Feb. 1, 2010– TALF will expire a few months later
• End large-scale asset-purchase programs– Scheduled to end by end of 2010 Q1
with slowing pace of purchases announced
FOMC Exit from Extraordinary and Massive Monetary Stimulus
FOMC Exit from Extraordinary and Massive Monetary Stimulus (Cont.)
• To reduce the credit-growth and money-growth potential of the current $1.1 TRILLION of excess reserves:– Begin reverse repurchase agreement
program– Raise interest rate on excess reserves– Establish a Fed term-deposit facility for
banks– Outright sales of assets
Use in combo. to increase
Fed funds rate
Timing of Exit Strategies
Depends on:• Long time lags for monetary policy
to impact economic growth and inflation
• Forecasts of when economy will return to more normal patterns– Cannot wait for return to actual high
resource utilization
Timing of Exit Strategies (Cont.)
• FOMC will focus particularly on anticipated resource utilization, inflation and inflation expectations in its decisions on exit timing
• Fed has no prior experience in creating or removing monetary stimulus of this magnitude and diversity
A Humble Note
“The way events have unfolded over the past few months simply has no precedent… No one knows the outcomes of an unprecedented event. No one.”
Zachary Karabell“The Economic News Isn’t All Bleak”
Wall Street JournalDec. 26, 2008, p.A13
The circulation of confidence
is better than the circulation of money.
- James Madison
Confidence Must be Restored in:
• Government leaders• Business leaders
– Especially bankers whose reputations are tarnished and diminished
• Workability and resilience of our institutions– Security breaches (White House, TSA)
• Fed Independence
• The economy is on a steadier positive trajectory.
• We have serious concerns about weaknesses in the labor market.
Economic Conclusions:
• The recovery depends on more than fiscal and monetary stimulus. They are necessary, but not sufficient for an economic recovery.
• True improvement requires the will and ability to overcome adversity, ending an attitude of complacency and entitlement.
• The U.S. has demonstrated this ability in the past and will continue to do so.
• The FOMC has already said, in essence: “We’ve done enough.”
Policy Messages:
Back of Tray
Words and Phrases to Never Use:
• Never again• Contained• This time it’s different
'81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09-6
-4
-2
0
2
4
6
8
10
Dec. Avg.
Euphoria
midpoint
Panic
Oil prices plunge
’87 stock run-up
’94 Recovery, EMG boom Irrational
ExuberanceNasdaq Bubble
Private Equity, CDO, Lending Boom
Secular Bear Stock Mkt ends
Oct. 87 Crash
Gulf War I
ERM crisis, Nikkei low Mex.
Default
Asian Crisis
Russian Default
Nasdaq Bust
Gulf War II looms
Subprime Crisis
Credit Suisse Global Risk Appetite Index Moderating
(1/12)
“The next few months are among the most important in U.S. history. Because of the financial crisis, Barack Obama has the bi-partisan support to spend $1 trillion in stimulus. But we must make certain that every bailout dollar, which we’re borrowing from our kids’ future, is spent wisely. …If we allow this money to be spent on pork, it will be the end of us.”
Thomas L. FriedmanNew York Times
Dec. 24, 2008, p.A21