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The U.S. Economy
…long and deep
The struggling American economy, officially in recession since December 2007, hopes to establish a foundation for renewed growth before the end of the year. A combination of home price stabilization, a bit of optimism from the national media, and the impact of massive amounts of stimulus should help establish just such a foundation.

The current U.S. recession is widely expected to be the longest and deepest of any since the Great Depression. A renewal of modest (but positive) growth during 2009’s final quarter—the consensus view of forecasting economists—would see the current recession approach 20-24 months in duration, nearly three times the length of the two prior recessions of the early 1990s and in 2001.

The Administration, the Federal Reserve, and the FDIC continue to announce new programs, each intending financial stabilization. Many of the programs being enacted have never been tried before.

Budget Deficits
…mind-boggling numbers
The phrase “being in uncharted waters” aptly applies to the level of deficit spending now underway. The new Administration’s spending initiatives will see a deficit likely approaching $2 trillion ($2,000,000,000,000) in fiscal year 2009, which began October 1, 2008. To the President’s defense, he did inherit economic and financial chaos from his predecessor.

Note that much of the $787 billion stimulus spending is geared to enhancements to the nation’s social safety net, with less toward economic stimulus. The $787 billion program clearly has a Democratic flavor to it.

Also note that much of the initial TARP program investment into financial institutions will, in my view, be returned to the taxpayer in coming years at a profit. Remember when the U.S. government bailed out Chrysler nearly three decades ago? The American taxpayer ultimately made money on that deal.

Unemployment
…higher and higher
The severe economic contraction that became widely felt during 2008’s final few months has ravaged U.S. employment. The U.S. economy suffered a net decline of 3.1 million jobs during 2008, the worst year since 1945. A similar number of job losses seems on tap this year.

The nation’s jobless rate is now 8.5%, with additional increases in store. The jobless rate could easily approach 9.5% within the next 8-12 months, with more bearish forecasters seeing a 10.0% or higher rate.

Inflation
…up or down?
Just as the escalation of oil and other commodity prices fueled the sharp rise in consumer inflation during 2007 and 2008’s first half, the plunge in those prices led inflation pressures much lower. When all was said and done, the Consumer Price Index rose 0.1% in 2008, the smallest rise in 54 years.

Note that widely divergent views are the norm regarding inflation during the next few years. One influential camp of economists sees major inflation pressures during 2010 and beyond resulting from massive budget deficits and highly aggressive monetary policy.

The other camp sees a Japanese-style deflation unfolding in coming years, tied to weak home and commodity prices and global recession. For now, we will take the middle road and suggest that inflation will remain low.

The Federal Reserve
…at historic lows
The Fed has been pulling out all the stops during the past 6-12 months, struggling to overturn financial paralysis that has engulfed financial markets. The Fed’s critical federal funds target rate, at an all-time low of 0.00%-0.25% since mid-December 2008, could easily stay at that level the entire year.

Long-Term Interest Rates
…low and lower
Thirty-year fixed-rate mortgages for conventional loans have remained near 4.75%-5.00% in recent weeks. Mortgage finance for higher-priced homes remains spotty in many communities.

Officials at both the Treasury and the Fed have indicated a desire to see mortgage rates approach 4.50%. Such lower rates would be perhaps the least costly way to see home prices stabilize and clear high levels of homes from the market.

The Global Economy
…going nowhere quickly
Much of the developed world is now in recession, with similar challenges for emerging markets around the globe. For the first time since World War II, the U.S., Japan, and Europe are in recession simultaneously. Such global weakness will likely persist well into 2010.

China is dealing with major challenges tied to economic slowing. The never-ending migration of millions of citizens annually from the farms to the factories has been disrupted as thousand of factories have closed due to sharply lower global demand for exported goods. Higher levels of social unrest could easily be experienced in China this year and next.

Japan has fallen back into recession, with the economy contracting at an alarming 12.0% annual rate during 2008’s final quarter. India has seen its growth rate cut nearly in half during the past year.

European politicians and business leaders were laughing at the U.S. during mid-2008 for the enormous financial mess we found ourselves in. They stopped laughing when the gravity of their own financial stress became more apparent. Recession across Europe and the U.K. could last well into 2010.

Life was good in Russia when oil prices exceeded $100 per barrel, with millions of people enjoying rising living standards. The plunge in oil and various commodity prices has clearly thrown a wrench into Putin’s grand plans.

Many South American nations are now struggling with lower prices for their prized commodities, including oil. Many nations suffer from high levels of government inefficiency and rampant corruption.

Canada is in recession as its major export customer…the United States…buys less. Weakness in energy prices has also slowed growth in Western provinces, while Eastern Canada struggles with a very weak auto sector. Mexico is likely to enter recession this year. The serious escalation in drug violence threatens the nation’s critical tourism sector.

The Bottom Line?
A serious U.S. recession will (hopefully) give way to stabilization and modest growth later this year or very early in 2010. We also expect…unprecedented budget deficits tied to massive “stimulus” spending…more employment pain…modest inflationary pressures this year…extremely low short- and long-term interest rates…and a sick global economy.

A final note? We Will Get Through This!

Fed Efforts

Note the data in the chart below. The Federal Reserve’s most recent economic forecast suggests that the U.S. economy will emerge from its lengthy and painful recession later this year or early in 2010.

The Fed’s forecast of 2.5% to 3.3% real (after inflation) economic growth during 2010 would be in line with many private sector forecasts, as well as in line with real average U.S. economic growth during the past 60 years. Note, however, the economic growth forecast for 2011. The forecast of 3.8% to 5.0% real growth essentially falls under the “boom” umbrella.

It is presumed that the Fed sees its historically aggressive monetary stimulus, combined with massive governmental fiscal stimulus, as not only overcoming the lengthy U.S. recession, but also leading to very impressive economic growth in 2011. Let’s hope so.

Employment Pain
The Fed expects the unemployment rate to approach 8.8% later this year. While the forecast does see some decline in the jobless rate during 2010 and 2011, the rate is not expected to return to a more acceptable 5.0% level until 2012 at the earliest. By comparison, the U.S. unemployment rate, currently at 8.5%, averaged 5.8% during 2008 and 4.6% during both 2006 and 2007.

The Fed’s forecast for inflation suggests it will remain under control, with a longer-term outlook ranging from 1.5% to 2.0%. Many economists would agree with this view, although there is a wide disparity between those forecasters who expect to see sharply higher inflation pressures in coming years versus those who see the most likely scenario being a Japanese-style deflation after 2010.

Recent weeks have seen the Federal Reserve announce a combined $1 trillion program to directly purchase U.S. Treasury notes and bonds, mortgage-backed securities issued by U.S. government agencies, and debt issued by Fannie Mae and Freddie Mac. The intent is to “push” 30-year fixed-rate conventional mortgages toward 4.50%, among the lowest on record.

The Fed has made it clear that the enormous expansion of its balance sheet to boost financial market flows…with newly created money…is temporary in nature, and will not ignite major inflationary pressures in coming years. Financial markets expect nothing less.

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