Sunday, June 7, 2009


Enough Adjustment?
Headwinds remain, but ready to recover

• Official recession ends soon

• Double-dip 2010 recession avoided
• Core inflation to fall on labor slack

This report updates our US economic forecasts.

The 2009 story has not changed much since our 27 March report, Break in the Weather. The official recession may soon be over. Consumers have cut back enough, as saving ratios have climbed to high enough levels, as long as asset prices can stabilize. On this front, stock prices have risen while house prices are still falling, but housing valuations appear cheap enough that a bottoming is in sight.

We stick with our view that GDP could rise as early as the second quarter, building up some strength in the second half of the year, but it will be a jobless recovery for a while, so unemployment will keep rising to about 9.75%. This should set the stage for a sizable decline in core inflation in 2010, down to under 1%. As a result, the Fed will not need to raise rates in 2010, providing a bullish backdrop for 10-year note yields despite the recent sell-off in response to deficit concerns. This will help keep mortgage rates low.

The loosening of financial conditions has been more than we anticipated over the past three months, and so we have taken out our “double-dip recession” scenario for the first half of 2010, where we now look for slightly positive growth rather
than slightly negative growth. This has had the effect of raising our 2010 year-average forecast from 0.5% to 1.9%.

However, 2010 growth will nevertheless be constrained and below trend, because significant financial headwinds remain and deleveraging will continue (but not enough to produce another recession, in our view).

Much of the upgrade to 2010 growth, however, is likely to be productivity led, so we have not changed our unemployment forecasts much. Indeed, payrolls could stay negative for much of this year and not stabilize until later in 2010, keeping wage growth and core inflation very low.

To see full report: US ECONOMICS