Outlook and Market Review - First Quarter 2010


Real GDP rose at an annualized 3.2% rate in the first quarter of 2010, according to the advance estimate from the Bureau of Economic Analysis. Real GDP grew 5.6% in the fourth quarter of 2009 and has now increased for three straight quarters, offering confirmation that the recession ended last year. Consumer spending and business inventories both provided large positive gains in the first quarter. Consumer spending was driven by a pent-up demand but consumer fundamentals remain weak. With the unemployment rate moving back up to 9.9% and little growth in income, consumers are not able to sustain the type of robust spending normally seen in this stage of an expansion. Increased labor productivity with slow wage growth has enhanced profitability that will help increasing hiring, but risk aversion remains high. The latest sovereign debt crisis in Europe rekindled market fear and raised concerns over financial institutions holding massive amounts of country debt. Bailouts for banking institutions have now shifted from a concern over bad mortgages to bad sovereign debt. A potential silver lining is a low and manageable level of inflation. While specific prices, like oil, rise there is not enough demand across the board for a general increase in price levels. The absence of inflation allows the Fed to continue its easy money policy for the rest of the year.

The stimulation provided by the federal government is slowly fading and state and local budget cuts mean that overall government spending will be a negative for economic growth throughout 2010. Business investment in equipment and software remains a bright spot and will continue to expand as profitability improves, but business construction spending continues to decline because of excess space. Housing conditions are improving and mortgage rates remain low, but there is a long way to go before housing recovers fully.

The economy will expand over the next few quarters, but growth will be slow as the boost from inventories fades and job creation slowly makes a dent in the eight million plus jobs lost in the downturn. A lack of inflation pressure will provide room for continued monetary stimulus. The federal deficit will continue to rise as a new bailout for Fannie Mae and Freddie Mac takes shape and potential bailouts of state and local governments materialize. Interest rates at the longer term end of the yield curve should ease upward while Fed policies keep short term rates low. However, the expected increases in interest rates in the second half of 2010 will be less than expected as private sector demand develops more slowly. Corporate profitability will be good as low costs of labor continue in leaner restructured firms.