Outlook and Market Review - Third Quarter 2005

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The Commerce Department announced a third quarter real GDP growth rate of 3.8%, which is slightly ahead of expectations. Third quarter growth makes the real GDP growth on a year-to-date basis a healthy 3.6%. The economy remains resilient to unexpected shocks in oil prices, weather damage, and increased uncertainty. Nevertheless, fourth quarter growth is likely to suffer as some of these shocks work through the system later this year. Higher energy prices and hurricane destruction have both hurt consumer and investor confidence as we move into the fourth quarter.

Fourth quarter GDP is likely to be closer to a 3% annual growth rate as the economy shrugs off delayed reactions to hurricane disasters and slowly adjusts to high but moderating oil prices. Consumer and investor confidence is low, which may dampen both consumption and investment spending going forward in 2005. Energy prices continue to be high but there is some offset by lower food prices. Overall price pressure is moderated by capacity utilization of only about 78%, well below the mid-80% levels required for inflationary bottlenecks in the rest of the economy. The Fed fund rate is almost sure to be 4.25% by the end of the year with small spreads for higher maturities. While interest rates will be somewhat higher overall, the 10 year Treasury bond yield is likely to be no higher than 4.9% at the end of the quarter.