Outlook and Market Review - Second Quarter 2009


The U.S. economy continued to contract in the second quarter with a 1% decline in real GDP following the revised declines of 6.43%, 5.37%, and 2.68% in the prior three quarters. If the downturn ends with the second quarter of 2009, the peak to trough decline in the economy would reach 3.9%. The downturn, which is the worst since the Great Depression, dates back to late 2007. After18 months of contraction, the economy appears to be stabilizing for the second half of 2009. The fiscal stimulus is likely to kick in with maximum impact just as the economy finds its bottom and begins a recovery. Even with the stimulus the recovery should be slow and uneven. Labor market improvement will lag the performance of the rest of the economy. Approximately 3.4 million jobs disappeared since the start of 2009 and 6.5 million jobs have been lost since the onset of the downturn. The plunge in wages and reductions in total compensation to workers over the last few quarters will hold back spending, aggravate credit conditions, and keep home foreclosures going.

Aggressive monetary policy and historic lows in short term interest rates are likely to continue throughout 2009. The depth of the economic downturn has offset the Fed’s easy money position, keeping inflation pressures low. The core personal consumption expenditure (PCE) inflation rate increased 1.7% on a year-ago basis in the first quarter. The PCE year-over-year change should remain below 2% with the core rate of about 1.25% through 2009. Long run fears of high inflation due to mounting government debt and the Fed’s easy money policies are on hold for now.

Many sectors of the economy are improving but any real expansion will require a full recovery in housing. Housing markets are linked to many other sectors of the economy that will not rebound until housing inventories shrink and new construction picks up. High rates of mortgage delinquencies and defaults suggest lingering problems in housing. Real GDP should see a small increase in the second half of 2009 as conditions stabilize and monetary and fiscal policy boost demand. Still, the expansion will be weak. There is little pent-up demand for autos and housing, which traditionally lead expansions.

Demand will slowly accelerate in 2010, with weak growth until the end of the next year. However, large downside risks remain. Efforts to address growing foreclosure could prove inadequate, leading to larger declines in house prices and to a further downturn in consumer spending. Also, financial markets remain vulnerable, and additional disruptions could further reduce the flow of credit, short-circuiting any recovery.