Consensus Forecasts and Market Summary

Although the U.S. economy is still weak and labor market conditions are poor, most recent U.S. economic data reports suggest the economic contraction has slowed while many forecasts, both government and private, point to the recession ending next quarter.  

Beyond 2009, the variances in growth forecasts increase as visibility diminishes over economic factors and government reforms.  Overall, however, the cumulative effects of policy stimulus and a broad overall inventory adjustment process are expected to favorably impact U.S. economic conditions provided stability holds in the financial markets.  

Generally, next year's U.S. economic growth expectations remain relatively slow, but positive, amid an expected backdrop of cautious businesses and consumers given a combination of high unemployment and uncertainty surrounding tax reform, healthcare reform, mid-term elections and the value of the U.S. dollar.

July 23, 2009:  There's little debate that several U.S. economic data outcomes have shown less-weakness in recent months, compared to late '08 and early '09, leading many economic forecasters (including the Fed) to believe the latest U.S. economic downturn is approaching a bottom and to raise their near-term economic forecasts.  On the more favorable side, consider that: 

• June U.S. data on existing home sales, released today, climbed to an annual rate of 4.89 mn, the highest since last October. 
• The fierce downtrend in housing starts ended its decline in January and has bounced around between a low annual pace of 479k (April) and a high of 582k (June, latest) since the beginning of the year.
• The 4-week moving average of weekly claims for unemployment insurance have declined to 566k, the least since January.
• Durable Goods Orders increased for a second straight month (in May) for the best back-to-back monthly outcome (2-month average gain of 1.6%) seen since Dec '07.
• ISM's non-manufacturing "services" index continued to signal contraction in June, however, the gauge's 47 outcome last month was the best seen since Sept '08 and the index has improved for 3 straight months.
• ISM's manufacturing index continues to signal contraction with the index @ 44.8 in June, however, the gauge has climbed for 6 straight months after reaching a near 29-year low in Dec '08.
• The trend in auto sales stopped declining in Feb reaching a 28 year low annual sales pace of 9.1 mn units and has since averaged a 9.7 mn annual pace.
• The Conference Board's gauge of leading economic indicators increased in June for a 3rd straight month signaling a potentially favorable turning point in the economy.

This week, in his semiannual monetary report to Congress, Fed Chairman Ben Bernanke said "the pace of (economic) decline appears to have slowed significantly, and final demand and production have shown tentative signs of stabilization.  The labor market, however, has continued to weaken."  

The Fed Chairman said "financial conditions remain stressed, and many households and businesses are finding credit difficult to obtain."  In addition, "businesses have continued to cut capital spending and liquidate inventories" while "the rate of job loss remains high and the unemployment rate has continued its steep rise."

On the positive side, Mr. Bernanke said "consumer spending has been relatively stable so far this year, and the decline in housing activity appears to have moderated."  

In all, however, Bernanke's comments arguably were not much of an endorsement for an imminent U.S. economic recovery and suggest the Fed Chairman's timetable for a meaningful and sustainable recovery is a ways off.  The Fed chief said "the FOMC believes that a highly accommodative stance of monetary policy will be appropriate for an extended period."

Current conditions:  The minutes of the June 23-24 2009 FOMC meeting, released July 15, described current U.S. economic conditions as weak but said the pace of decline was moderating.  Highlights:

• Employment was still falling but the reductions in employment had slowed somewhat.  Rising labor force participation contributed to the increase in the unemployment rate.  Workweeks were being trimmed and total hours worked were falling significantly. 
• Manufacturing production was cut further in response to excess inventories and soft demand.
• Consumer spending appeared to be holding reasonably steady after shrinking in the second half of 2008 but nonetheless remained weak. The continued sluggishness in consumer expenditures mainly reflected falling employment and sharply lower wealth. 
• Single-family homes sales and construction had apparently flattened out due, in part, to the improvement in housing affordability that resulted from low mortgage rates and declining house prices.  The sector was viewed as still vulnerable to further weakness.  
• Capital spending declines were smaller than those seen earlier in the year.  Real investment in equipment and software continued to contract but at a slower pace.
• Transportation equipment outlays seemed to be firming after shrinking for an extended period.
• Computing equipment spending decline appeared to be leveling off, although businesses continued to cut their real outlays on software.
• Spending on equipment, outside of high-tech and transportation, seemed to have dropped less rapidly in the second quarter than in the first quarter.
• Nonresidential building demand, outside of the energy-related sectors, remained extremely weak and financing was difficult to obtain.
• Business inventories remained elevated but large production cutbacks in recent quarters allowed producers to stem the rise in stocks relative to sales.
• Purchasing managers indexes rebounded from the exceptionally low levels reached in the first quarter.
• Consumer price inflation was fairly quiescent in recent months.  Survey measures of long-term inflation expectations showed no signs of moving lower despite excess labor and production capacity. Concerns about deflation were reduced.  

Reconciling Bernanke's comments with the Fed's projections:  In the June 23-24 FOMC minutes, the Fed's range of projections for real U.S. GDP suggests Bernanke's cautious tone for GDP extends into 2010 and that monetary policy will remain in a holding pattern.  FOMC participants generally expect that, after declining in the first half of this year, output will increase slightly over the remainder of 2009 with recovery expected to be gradual in 2010, with some acceleration in activity in 2011. 

Much of the growth improvement that is expected hinges on inventory rebuilding that would lead to increases in production, which would support growth in hours worked and eventually in investment outlays.  

Fed's U.S. GDP forecasts:  The Fed's latest range of real GDP projections are as follows: 2009 of -1.6% to -0.6%, 2010 of +0.8% to +4.0% and 2011 of +2.3% to +5.0%.  The wide-range in these forecasts obviously speaks to significant differences of opinion (at the Fed) regarding the outlook and is another indication that the Fed will likely take its time unwinding its liquidity and credit support programs.  It also suggests there will likely be some inconsistency in publically delivered economic outlooks by senior Fed officials over the next couple of months. 

Looking ahead:  The Fed's latest projections for U.S. 2009 - 2011 unemployment and inflation:

• Unemployment:  The employment situation was likely to be downbeat for "some time".  The unemployment rate was projected to peak at the end of 2009 while the projected declines in 2010 and 2011 would still leave unemployment well above FOMC's views of the longer-run sustainable rate. Growth in unit labor costs was expected to continue to be restrained in coming quarters. The Fed's latest range of unemployment projections:  2009 of 9.7% to 10.5%, 2010 of 8.5% to 10.6% and 2011 of 6.8% to 9.2%.  
• Inflation:  All FOMC participants expect that inflation will be somewhat lower this year than in recent years, and most expect it to remain subdued over the next 2 years.   The low level of resource utilization was projected to result in an appreciable deceleration in core consumer prices through 2010. The Fed's latest range of PCE inflation projections (personal consumption expenditure inflation, which was 0.1% yoy in May '09) are: 2009 of 1.0% to 1.8%, 2010 of 0.9% to 2.0% and 2011 of 0.5% to 2.5%.  

Offsetting considerations:  In his report to Congress this week, Bernanke said the pace of inventory liquidation (see following chart) in coming quarters "may support a turnaround in activity" but that "job insecurity, together with declines in home values and tight credit, is likely to limit gains in consumer spending.  The possibility that the recent stabilization in household spending will prove transient is an important downside risk to the outlook."

To some degree, the context of Bernanke's caution over U.S. economic prospects and his sanguine posture towards inflation risks, reflect his hope that very accommodative monetary policy can continue to be delivered - absent instability in the markets - in order to promote a sustained economic recovery.

The minutes of the June 23-24 FOMC meeting said the Fed's staff "anticipated that financial markets and institutions would continue to recuperate, monetary policy would remain stimulative, fiscal stimulus would be fading, and inflation expectations would be relatively well anchored." 

Fed funds futures:  According to the futures market, the current 0% to 0.25% fed funds rate is expected to remain in place until the end of 2009 followed by increases of approximately 25 bps in each of Q1 and Q2 next year and subsequently stepping up with larger increases in Q3  and Q4 '10 for a year-end 2010 expected target funds rate of approximately 1.65%.

Market consensus:  Moving away from the Fed's outlook to the Bloomberg consensus projection, which extends through Q1 2010, we observe a steady and modest improvement in economic growth expectations over the next few quarters.   

The latest Bloomberg consensus forecasts, comprised of nearly 60 forecasters, was based on projections collected between July 2 and July 8 and published July 10.  The consensus (median) forecasts predicted:

• U.S. GDP would decline at a 1.8% annual rate in Q2 '09, increase 1.0% in Q3, rise 1.9% in Q4 and increase 2.2% in Q1 '10.   The first reporting of Q2 U.S. GDP is scheduled for July 31.   
• U.S. unemployment would climb to 9.8% in Q3, 10.0% in Q4 and 10.1% in Q1 '10.  Latest unemployment rate was 9.5% in June.
• U.S. headline CPI would decrease 1.8% yoy in Q3, rise 1.0% in Q4 and increase 1.6% in Q1 '10.  Latest yoy CPI was minus 1.4% (June yoy).

As can be seen from the following table, the July forecasts for Q3 '09 U.S. growth shows a noticeable upgrade relative to what was previously anticipated.  The improvement in Q3 growth expectations is consistent with less-weakness seen in a number of recent U.S. economic data outcomes.

Rate outlook:  The outcome for U.S. Treasury yields and swap rates over the near-term is made more complex by the intermittent flight-to-quality status of U.S. Treasurys and the lack of near-term inflation pressures despite the significant deterioration in U.S. fiscal conditions.

The following chart highlights the mid-2010 Bloomberg consensus interest rate forecast (per above) relative to the current interest rate environment and the mid-2010 forward market.

• Steep yield curve:  The current yield curve,  the consensus forecast and the forward market all reflect a steeper yield curve - pointing to an expectation of eventual economic recovery, concern over increased debt supply and a near-term continuation of low short-term yields.  Historically, a steeper yield curve, however, has also reflected the expectation of higher short-term yields materializing in the future.

• The July 10th consensus forecast anticipates U.S. Treasury yields ending mid-'10 higher than where they are today (July 23).

Robert Podorefsky, Interest Rate Strategist  (617) 973 - 4091