Outlook and Market Review - Third Quarter 2008


The economy shrank by .3% in the third quarter of 2008 according to the advanced estimate. Most analysts expect a revision toward an even weaker performance. Unemployment, which normally lags economic performance, increased to 6.5% in October from 6.1% in September. Nonfarm payrolls declined by 1.2 million since the beginning of 2008, with more than 500,000 cut in just the past two months. Dismal sales figures and weak manufacturing data suggest further increases in the unemployment rate to as much as 7% early in 2009 and 8% by the end of 2009. Consumers are facing declining income, declining wealth, deteriorating credit conditions, job fears, and very low confidence. Investment spending continues to fall led by a continued slide in residential investment and weaker non-residential investment. Declines in imports outpace the declines in exports, offering some help to GDP. Government spending is the only component of aggregate demand left to keep the economy from a very pronounced economic slide. Inflation pressures are easing as the economy grinds downward and oil prices weaken.

Monetary policy continues to pump liquidity in the short term market to bring down the Fed Fund rate. The 1% target may fall to 0% by the end of the year. Traditional Fed policies aimed at short term interest rates and increased bank reserves are impotent in this economy. More dramatic moves to ease long term rates have not yet been put on the table, but are absolutely necessary to revive the housing market and investment spending. Even the early attempts to use the $750 billion “recovery” fund to purchase toxic mortgages has been revised to seek more direct ways to stimulate bank lending. Consistent and sound strategies to revive the housing market and stabilize financial institutions must be forthcoming. Consumer confidence and sentiment are at rock bottom with declining equity and home values, lost jobs, heavy debt burdens, and little confidence in government plans to improve the situation. The gloomy sentiment that permeates the economy poses a danger of becoming a self fulfilling prophecy as consumers and investors withdraw, causing further declines in the economy.

Analysts, to include the Federal Reserve economists, are revising forecasts of economic activity downward. Fourth quarter real GDP is likely to fall at least 1% on a seasonally adjusted basis. Unemployment will edge up toward 6.8% by the end of the year with no real improvement in housing. The Fed Fund rate will move to 0% with little easing in long term rates. Bank lending will improve but credit standards will remain high. The only good news in the near future is a lower inflation rate but there may be a new concern for deflation.