Financial Perspectives – Summer 2009
The Worst Is Over
Timely Commentary from Raymond James Chief Economist Scott Brown
Recent data have suggested that the worst part of the economic decline is behind us. That’s not the same as a recovery, but a slower rate of decline is the first step toward bottoming out. Monetary and fiscal policy should contribute to a gradual recovery into 2010. As with the last two recessions, it will be some time before the economy returns to its potential.
As a recession develops, bad news typically feeds on itself. Eventually, however, what economists call “automatic stabilizers” begin to kick in. Government transfer payments – unemployment insurance benefits in particular – partly offset the loss in labor income. More important, personal tax payments fall faster than the loss in wage income, cushioning the downside.
In addition, the fiscal stimulus package, approved in February, is now coming online. Tax withholding fell in April, and tax rebate checks have gone out to senior citizens. Note that half of the fiscal stimulus package will arrive in 2010 and beyond, helping to shore up the economic recovery.
Part of the deficit represents the cost of supporting the banks without counting the benefit (equity or debt) that the government is receiving in return. The Obama administration seems intent on reducing the deficit once the economy recovers.
The recession, the bank rescue and the fiscal stimulus have had a significant impact on the federal budget deficit, pushing the expected shortfall for the current fiscal year to more than $1.8 trillion. However, part of the deficit represents the cost of supporting the banks without counting the benefit (equity or debt) that the government is receiving in return. The Obama administration seems intent on reducing the deficit once the economy recovers. However, over the next several years, there will be tough choices on spending and taxation.
The Federal Reserve has re-written the playbook in this recession, lowering the overnight lending rate to essentially zero, creating a number of special lending facilities, and buying mortgage-backed securities and long-term Treasury debt. The Fed is confident that it can unwind this accommodation without a significant increase in inflation. Officials have spent a considerable amount of time working out the end game. Some market participants aren’t convinced, however, and we’ve seen some pressures on commodities and the dollar.
The last two recessions were relatively short by historical standards, but recovery took a long time. The 1990-91 recession ended in March 1991, but the economy wasn’t firing on all cylinders until late 1993. The 2001 recession ended in March of that year, but we didn’t start adding jobs again until August 2003.
History has shown that recessions that are caused by financial crises tend to be more severe and longer lasting. This recovery is expected to be gradual, with plenty of excess slack – and hence, limited inflation pressure – for some time.
The Fed has not targeted specific levels of mortgage rates or the 10-year Treasury note yield, but its asset purchase program has been designed to keep those rates low. Still, Treasury yields are likely to rise along with confidence in the economic recovery, while corporate bond spreads (relative to Treasuries) should narrow. The stock market is a forward-looking indicator, and gains usually arrive in the early stages of the recovery.
There is no assurance any of the trends mentioned will continue in the future.
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The information contained in this newsletter has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. We may, from time to time, have a position in the securities mentioned and may buy or sell such securities in the course of regular business.
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