INSIGHT: Doom, gloom - and a glimmer of recovery

19 February 2009 15:19  [Source: ICIS news]

US central bank economists see recovery in Q3 or Q4By Joe Kamalick

WASHINGTON (ICIS news)--The Federal Reserve Board has revised its US economic outlook sharply downward, with the US central bank’s top analysts saying gross domestic production (GDP) could fall by 1.3% this year and recovery could take up to six years.

In minutes of the board’s rate-setting meeting of 27-28 January and with a new, longer-range economic outlook, Fed governors and senior staff forecast “that real GDP would contract this year [and] that the unemployment rate would increase substantially”.

“Given the strength of the forces currently weighing on the economy,” said the central bank analysts, it is “generally expected that the recovery would be unusually gradual and prolonged”.

The board governors and senior analysts participating in last month’s meeting “anticipated that unemployment would remain substantially above its longer-run sustainable rate at the end of 2011, even absent further economic shocks”.

A sustainable level of unemployment - sometimes called the “natural rate” - is the average of joblessness over a period of years in an economy with normal growth of 3-3.5%.  For the US, sustainable unemployment is generally said to be in the 4-5% range.

The nation’s most recent unemployment measure was at 7.6% in January.

Although the Fed’s consensus is for the beginning of a recovery during the third or fourth quarter this year, the upturn will be razor-thin at first and will take a long time to reach normal economic growth.

The minutes and outlook noted that a few of the Fed’s top economists “indicated that more than five to six years would be needed for the economy to converge to a longer-run path characterised by sustainable rates of output growth and unemployment”.

“In their discussion of the economic and financial situation and the outlook for the economy, participants [in the 27-28 January Fed meeting] agreed that the economy had weakened further going into 2009,” the minutes said.

“The incoming data, as well as information received from contacts in the business and banking communities, indicated a sharp and widespread economic contraction both domestically and abroad,” the Fed said.

“Participants generally saw credit conditions as extremely tight, with financial markets fragile and some parts of the banking sector under substantial stress,” the analysis added.

Unemployment is expected to rise substantially through the beginning of 2010 before edging down over the remainder of that year, the central bank said, suggesting that joblessness could nudge 9% by early 2010.

In their earlier outlook, issued in October last year, Fed economists had forecast 2009 GDP at a meagre 1.1% growth rate or perhaps dipping into negative growth with a narrow GDP decline of 0.2%.

Now, however, the outlook is for 2009 to see a decline in GDP of at least 0.5% and as much as 1.3%.

“In explaining these downward revisions, participants referred to the further intensification of the financial crisis and its effect on credit and wealth, the waning of consumer and business confidence, the marked deceleration in global economic activity, and the weakness of incoming data on spending and employment,” the outlook said.

“Participants anticipated a broad-based decline in aggregate output during the first half of this year; they noted that consumer spending would likely be damped by the deterioration in labour markets, the tightness of credit conditions, the continuing decline in house prices, and the recent sharp reduction in stock market wealth.”

The Fed’s analysts said they could see no indication that the housing sector was beginning to stabilise. Indeed, the Commerce Department reported this week that US housing starts had fallen to an all-time low in January.

Rock-bottom housing prices and low mortgage rates had increased housing affordability, the Fed noted, “but concerns that house prices may fall further appeared to be holding back potential buyers”.

A new housing stimulus or rescue plan announced by President Barack Obama this week is designed to ease if not halt the flood of foreclosed homes into the market, but the effect of that plan may take months to become apparent.

Along with housing, general business investment in equipment is a major downstream driver for chemicals and resins production. But as with housing, the Fed sees still more bad news to come on that score as well.

“Participants also noted that other categories of business investment [beyond commercial real estate] were contracting; they expected the rapid contraction to continue in coming quarters,” the minutes said.

“Equipment investment had declined particularly sharply, reflecting weak sales, tighter credit and substantial uncertainty about future economic conditions and government policies.”

“Lower energy and commodities prices, while supporting consumer spending, had reduced investment in oil, gas and mineral extraction,” the Fed noted, adding: “Outside of the agricultural sector, business contacts had reported sizable cutbacks in their planned capital expenditures for 2009.”

Turning to the global economy and the prospects for renewed US export trade - which almost alone was responsible for what little growth the US had in late 2007 and early 2008 - the Fed had more bad news.

“Participants indicated they had been surprised by the speed and magnitude of the slowdown in economic growth abroad and the resulting drop in demand for US exports.”

“Moreover, participants did not expect foreign economies to rebound quickly, suggesting that net exports would not provide much support for US economic activity in coming quarters,” the analysis said.

Still, the central bank’s top economic minds anticipate that “a gradual recovery in US economic activity would begin during the third or fourth quarter of this year as the economy begins to respond to fiscal stimulus, relatively low energy prices and continuing efforts to stabilise the financial sector and increase the availability of credit”.

Indeed, the seed of recovery may be germinating even now under recession rains.

“Several participants noted that firms’ efforts to control inventories as sales declined had contributed to the rapid downturn in production and employment in recent quarters,” the minutes noted.

“But the resulting absence of widespread inventory overhangs might spur a prompt pickup in production in many sectors later this year once sales begin to level out or turn up,” the analysis said.

As for Fed interest rates, the meeting noted that US inflation rates are “expected to be quite low for several years” and that “keeping the target range for the federal funds rate at 0% to .25% would be appropriate”.

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By: Joe Kamalick
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