Outlook and Market Review - Second Quarter 2008

Summary: 

Advanced estimates show that the economy’s GDP grew at a 1.9% annual rate in the second quarter of 2008 following a revised growth rate of .9% in the first quarter. For the past year, GDP grew 1.8%, which is well below a target rate of 3% for sustainable growth. Recently revised data from the 2004 through 2007 period provide a 2.6% growth in real GDP. While the revised growth rate of -0.14 for the fourth quarter of 2007 is not consistent with a technical definition of recession, the economy is clearly mired in a very slow growth mode. Unemployment increased to 5.7% as labor markets weakened, but the unemployment rate is a lagging indicator and is normally much higher in a severe downturn or recession. Inflation continues to loom on the horizon as food, energy, and energy related price growth exceed targets. Foreign products are more expensive with the weaker dollar, and consumers have reduced imports. It remains to be seen if the positive boost to the economy from improved trade will be enough to keep the economy going until financial markets and housing markets work through the credit debacle.

Consumer confidence and leading economic indicators are sinking, even though July provided a respite from the plunge of earlier months. The Fed appears to be at the end of its interest rate cuts with a 2% Fed Fund rate. Even with negative real interest rates for bank borrowers there are limits to the influence of lower short term rates on longer term investment decisions. Worse yet, recent minutes of the Fed’s Open Market Committee suggest that the balance of Fed attention is shifting to inflation away from the economic slowdown. A stronger dollar and lower inflation may now dominate the Fed’s radar with higher interest rates as a target later in 2008. For the remainder of 2008 the economy is likely to grow at a 2.5% rate with continued concerns for the stability of financial markets. Additional federal regulation of financial markets linked to increased efforts to work through defaults and bankruptcies will take time to restore confidence, allow liquidity, and return to more normal credit markets. Interest rates are likely to move up in response to higher expected inflation and higher credit risk premiums. The federal budget deficit will continue to grow and limit many of the fiscal initiatives that any new President of the U.S. may want to implement.