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Monthly Economic Outlook

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The Recovery Will Be Agonizingly Slow

Wed, Oct 7 2009, 07:26 GMT
by Wells Fargo Research Team

Wells Fargo Investments, LLC


U.S. Overview

“The Recovery Will Be Agonizingly Slow”

So it indeed has been. As this short quote from the Executive Summary of our 2009 Annual Outlook (published in December 2008) neatly summarized, the economic recovery faces a number of secular challenges that will alter the pace and composition of growth. For many decision-makers, the outlook for 2010 suggests continued change and adjustment to an altered reality of more government/less private sector contributions to growth, greater caution/less leverage for consumer spending, greater prudence/less speculation in lending and the importance of exports in moving the U.S. economy.

Even though our outlook for continued growth in the overall economy would suggest a normal cycle, the underlying forces in this economy are anything but normal. Much of the near-term gain in growth reflects federal, not private spending; foreign buying via exports, not domestic spending and production to rebuild inventories, not for new final sales. These odd characteristics of our growth in the short term give rise to questions about the sustainability of the recovery over time.

Finally, our outlook is framed, as it has been for two years, by the character of America’s evolving credit cycle. This credit cycle will not be a repeat of the past. We are still searching for that new balance in private and public leverage. We have not yet defined the limits of federal fiscal and monetary support. We are unsure of continued foreign purchases of U.S. securities and what price foreign investors might be willing to pay.

International Overview

Is Coordinated Policy Easing Still Appropriate?

Leaders of the G-20 countries recently agreed to “avoid any premature withdrawal of stimulus” in order to secure a “durable recovery.” Policy stimulus may be appropriate for many advanced economies, which probably will experience sluggish upturns due to further deleveraging, and we expect that most major central banks will maintain their respective policy rates at extremely low levels through much of next year. However, bona fide recoveries appear to be taking hold in many parts of the developing world, and it is no longer apparent that continued policy accommodation remains in the best long-run economic interests of many of these countries.

Consider Brazil, for example. Although the Brazilian inflation rate has trended lower since the end of last year, we project that it will begin to rise again in mid-2010 as growth strengthens and commodity prices trend higher. With budding inflationary pressures, continued policy accommodation would not be appropriate. The Reserve Bank of Australia recently surprised most investors by hiking its main policy rate by 25 bps, and central banks in many developing countries will likely begin their own tightening cycles early next year as well. We do not mean to imply that developing countries will slam on the brakes, thereby threatening to derail the incipient global recovery. Inflation is generally benign at present, and there is no need for excessive tightening. However, policy will need to become less accommodative in many developing countries or inflation could become a major problem again.

Published on  Wed, Oct 7 2009, 07:26 GMT

11

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The Recovery Will Take Time to Build Momentum

Wed, Sep 9 2009, 09:06 GMT
by Wells Fargo Research Team

Wells Fargo Investments, LLC


U.S. Overview

The Recovery Will Take Time to Build Momentum

Forecasts for economic growth during the second half of this year and 2010 have been steadily ratcheted up as most of the monthly economic indicators have come in better than expected. We have raised our own estimate modestly. We now see real GDP rising at a 3.7 percent annual rate, which is 0.3 percentage points higher than one month ago. Estimates for real GDP growth during the fourth quarter and 2010 are essentially the same as they were one month ago, and our first look at 2011 calls for real GDP to rise 2.5 percent.

The long string of real GDP gains seems a bit odd coming just as the unemployment rate approaches 10 percent. Much of the near-term improvement comes from a narrowing of the trade deficit and a smaller inventory drawdown. Inventories are “only” expected to decline by $100.0 billion in the current quarter, less than the prior quarter’s $159.2 billion plunge. The smaller decline will add 1.8 percentage points to third-quarter growth and 1.7 percentage points to the fourth-quarter numbers.

There is also some real improvement taking place. Stronger economic growth overseas is boosting demand for exports, helping further narrow the trade deficit. Fiscal stimulus dollars are also flowing a little more freely. Federal government spending is expected to average a 6.0 percent pace for the next three quarters, helping offset continued weakness of state & local government and the private sector.


International Overview

Has the Global Economy Turned the Corner?

Following five consecutive quarters of contraction, it appears that real GDP growth in the euro area is turning positive again. However, there are a few important countries in the Euro-zone in which consumers became highly geared over the past few years. Therefore, growth in the overall euro area could be held back somewhat over the next year or so as these consumers delever. With inflation benign and the sustainability of the recovery still in question, the European Central Bank will likely refrain from tightening policy.

The British economy, which plunged into its deepest recession in decades, is also exhibiting incipient signs of recovery. Like their counterparts in some continental economies, British consumers levered up earlier this decade. Therefore, it seems that a period of consumer retrenchment is in store. In our view, the Bank of England will also be on hold well into next year.

If there is a region of the world where recovery has clearly taken hold already, it would be Asia. China is leading, but most other Asian economies have also posted positive rates of GDP growth, at least on a sequential basis. Asian central banks likely will be the first institutions to hike rates, but policy tightening probably won’t get under way in the region until sometime next year. Inflation is benign in most Asian economies, and the outlook for many western economies, which are important trading partners for the region, remains uncertain.

Published on  Wed, Sep 9 2009, 09:06 GMT

3

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The Recovery Is Beginning to Take Shape

Wed, Aug 12 2009, 11:50 GMT
by Wells Fargo Research Team

Wells Fargo Investments, LLC


U.S. Overview

The Recovery Is Beginning to Take Shape

We believe the recession ended around the middle of this year and that a recovery has begun to take hold. Real GDP is expected to rise at a 3.4 percent pace in the third quarter and average a 3.0 percent pace for the second half of this year. The improved outlook reflects recent revisions to the underlying GDP data and a sharp reduction in inventories. The initial success of the cash for clunkers trade-in program has also bolstered our outlook for consumer spending. Aside from these changes, our forecast remains close to its earlier track.

Private domestic demand is expected to remain weak throughout the first year of the recovery, averaging just a 1.0 percent pace. Consumer spending will be constrained by rising unemployment, sluggish income growth, declines in household wealth and higher taxes, particularly at the state and local level. Outlays for plant and equipment will also take some time to recover. Businesses are awash in excess capacity and continue to focus on strengthening their balance sheets. Commercial construction will be another drag on economic activity during the early part of the recovery but homebuilding appears set to make a slight positive contribution to growth.

The sluggish start to the economic recovery should allow the Federal Reserve to keep short-term interest rates on hold through the middle of next year. Once the risks of the economy backsliding have passed, the Fed will move quickly to bring the federal funds rate back to a neutral level.

International Overview

Rate Hikes Are Not Imminent in Most Countries

Economic data that have been generally stronger than expected in most countries recently have raised the specter of eventual monetary tightening. In our view, however, rate hikes are not just around the corner. The Bank of England recently announced an increase in the size of its asset purchase program, a form of unconventional monetary easing, to ensure that the economy, which is showing signs of stabilization, does not lurch lower again. Monetary tightening does not seem to be on the minds of most policymakers at the European Central Bank either due to sluggish growth at present or benign inflation. We expect that both the Bank of England and the ECB will maintain their policy rates at current levels well into next year.

If there is an area of the world in which monetary policy could conceivably be tightened, it would be Asia where many economies are clearly expanding again. Even in Asia, however, most central banks probably will keep policy rates unchanged for the foreseeable future. The region has extensive trade ties with the rest of the world, and policymakers in most Asian countries probably want to be assured that incipient recoveries in western economies are sustainable before they begin to take back policy support. Although Asian central banks likely will be the first to tighten policy, we think that the first rate hikes are still months in the future.

Published on  Wed, Aug 12 2009, 11:50 GMT

7

0

Not Out of the Woods Yet

Wed, Jul 8 2009, 07:07 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Overview

Not Out of the Woods Yet

Optimism about the apparent ending of the recession has been tempered by the reality of substantial further deterioration in employment conditions and ongoing struggles with state and local government budgets. Real GDP is expected to rise slightly during the third quarter as inventory liquidations slow dramatically and consumer spending is revived. The ending of the recession, however, does not mark the end of the economy’s troubles. Economic activity will likely remain subdued well into 2010 and the unemployment rate will likely rise through the middle of next year, topping out at around 10.5 percent.

There are considerable risks to the forecast. On the upside, there is a great deal of stimulus in the pipeline, including the $787 billion economic recovery act, low interest rates, the completion of a colossal drawdown in inventories and the prospect of falling gasoline prices. On the downside, employment losses remain massive and the unemployment rate continues to increase. Moreover, hours worked and earnings are down even more than employment, which is leading to incredibly sluggish wage growth. Household wealth has also taken a huge hit and many state and local governments are grappling with huge budget shortfalls. The net result is likely a very sluggish recovery, with real GDP growth not returning to a strong enough pace to reduce the unemployment rate until the second half of 2010. With growth remaining subdued, inflation should continue to moderate well into next year, allowing the Fed to remain on hold through the middle of next year.

International Overview

Some Signs of Stabilization

Global economic activity contracted sharply in the first quarter, but there have been some tentative signs of stabilization more recently. The region showing the most promise at present is Asia. The manufacturing PMI in China has been in expansion territory for four consecutive months, and industrial production in many other Asian economies has strengthened as well. Banking systems in the region were generally not leveraged, at least not to the same extent as their counterparts in the West were, and most Asian governments responded to the crisis with sizeable fiscal stimulus programs.

Unfortunately, signs of positive growth in Western Europe have been much scarcer. The best thing that can be said about Western Europe is that the rate of economic contraction in the second quarter appears not to have been as rapid as in the previous quarter. Growth in Western Europe should turn positive in the next quarter or two, but the initial pace of recovery probably will be sluggish. Many economies in Eastern Europe, which went on a borrowing binge earlier this decade, are in depression at present. Eastern Europe likely will be the last major region to emerge from its slump.

The global economy is on pace to register a year of negative growth for the first time in decades. Although global growth should turn positive again next year, most major economies likely will expand at sub-par paces, at least initially. With economic growth remaining weak, inflation should remain benign on a global basis over the next few years.

Published on  Wed, Jul 8 2009, 07:07 GMT

7

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Despite Severe Headwinds, a Recovery is Near

Wed, Jun 10 2009, 06:52 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Overview

Despite Severe Headwinds, a Recovery is Near

Our forecast incorporates the improved tone of recent economic reports as well as the anticipated bounce-back in motor vehicle production from the current severely depressed levels in the third quarter. We now expect third quarter GDP to be solidly positive, which means the recession will likely end this summer.

While the recession may be finally coming to an end, significant challenges remain. The housing bust is still playing out, and the credit markets are not functioning the way they should. Moreover, while layoffs are slowing, they still remain way too high. Nonfarm employment is likely to continue declining into early 2010 and the unemployment rate will not likely top out until the middle of next year.

As has been the case at the end of previous recessions, a huge swing in inventories will provide the thrust for the rebound in economic activity. Motor vehicle production has been slashed in recent weeks and is running well below even the recent weak pace of sales. As a result, inventories are falling rapidly. The drop in inventories should slice a percentage point off second quarter growth. That decline, along with the continued pullback in business fixed investment and another modest drop in consumer outlays, should put second quarter real GDP down at a 3.4 percent pace. The second quarter’s sharp drop in inventories also sets the stage for a rebound in economic growth in the third quarter, as motor vehicle production is ramped up and consumer spending rises modestly.

International Overview

Global Economy Looking a Bit Better

After plunging very sharply in the first quarter of 2009, global economic activity may be starting to level out with Asia leading the way. Indeed, production in some Asian economies is starting to grow again due at least in part to a resumption of global trade. In Europe, it does not appear that economic growth has turned positive yet, but the pace of contraction in the second quarter is surely less rapid than it was in the first quarter. Real GDP growth should turn positive in most major economies later this year, but the pace of the global expansion next year likely will remain relatively sluggish.

Signs that the global economy may be nearing a bottom have contributed to the back-up in government bond yields recently. Over the past month, the yield on the 10-year Treasury security is up about 70 bps. Comparable yields in Europe have also risen over the past few weeks.

The dollar has depreciated somewhat versus most currencies, especially vis-à-vis the currencies of most commodity producers and developing economies. In our view, the greenback will strengthen in the months ahead as signs of recovery start to show up in the United States before they do in Europe. In addition, “commodity” and emerging market currencies should give up some of their recent gains as investors begin to question the overall vigor of the global expansion. That said, these currencies likely will appreciate next year as the global economic recovery begins to pick up steam.

Published on  Wed, Jun 10 2009, 06:52 GMT

4

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Economic Recovery: Unusual Shape, Unusual Style

Wed, May 13 2009, 10:24 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Overview

Economic Recovery: Unusual Shape, Unusual Style

Despite the volatility of monthly economic releases and policy prescriptions, surprisingly little in the outlook has deviated from the pattern of the recovery as outlined in our annual outlook published last December. Economic recovery is expected to start later this year. Weakness in consumer spending has begun to give way to gradual improvement. Business spending continues to decline. Housing remains weak. A significant inventory correction in early 2009, combined with a gradual recovery in final sales, produces an improvement in aggregate demand. Inflation remains low while corporate profits remain weak. Federal Reserve policy has kept short rates low while long Treasury rates are expected to rise.

While this recovery has followed traditional patterns, we continue to see that the recovery will differ in both character (less diversified) and strength (weaker) relative to past recoveries. The recovery will disappoint both citizens and policymakers, which will mean more difficult decisions. A subpar recovery in output, employment and consumer incomes will mean consumer, housing, commercial real estate and government spending will not return to what many would perceive as normal. An ongoing economic and psychological adjustment to a new, lower equilibrium long-run growth rate for the economy will drive choices on the limits of our economic resources to meet our aspirations in a global economy.


International Overview

Is the Dollar’s Rally Over?

The dollar has recently moved to the bottom of the trading range that is has respected versus most major currencies since the beginning of the year. Since the middle of last year there has been a tight correlation between the value of the dollar and risk aversion. When risk aversion rises, the dollar tends to strengthen and vice versa. The recent rise in stock markets and the tightening of credit spreads has been associated with the depreciation of the dollar over the past few weeks. However, the correlation between risk aversion and the greenback has not always been so tight, and we expect that the effects of economic fundamentals on the value of the dollar will sooner or later reassert themselves. Because we expect that the United States will show signs of economic stabilization and eventual recovery sooner than other foreign countries, we look for the dollar’s uptrend to resume after this short-run correction runs its course. We are not ready to throw in the towel on the greenback.

In our view, the recent deprecation of the dollar does not reflect unease among foreign investors. Not only have there been no new developments on the U.S. fiscal front, but government bond yields in many foreign economies have risen more or less in line with Treasury yields lately. Rather, the recent rise in government bond yields in most major economies seems to reflect stronger-than-expected economic data that have raised hopes of economic stabilization and eventual recovery in many major economies.

Cyclical Recovery

Consumer and government spending, along with a moderation of the drag from housing, provide the basis for an improvement in aggregate demand leading to recovery in the second half of this year. Consumer spending, which dropped sharply in the prior two quarters, grew modestly in the first quarter. Consumer sentiment has improved, but weakness in the job market and income growth will limit spending. Saving rates will rise and remain higher as many households seek to rebuild their wealth. Government purchases are expected to be a significant plus for the economy in the short run. Finally, housing has shown some evidence of improvement as sales of existing homes have been stable and affordability has improved. Mortgage rates remain low and unsold housing inventory has declined.

Yet weakness remains evident for business fixed investment. Orders remain weak relative to shipments. This is consistent with declining profits, high levels of unused plant capacity and a downshift in the pace of expected future sales. Commercial real estate will remain moribund due to high vacancy rates and limited credit. As in traditional economic cycles, the reduction in business inventories over the last two quarters with the rise in final sales sets the internal dynamic of the economy on its path towards recovery. Unfortunately, net exports, which added to growth in the prior expansion, remain weak and we expect they will actually detract from growth in the second half of this year.

The Problem of Reinventing the Past

Decision-makers, however, must recognize that the cyclical recovery this time is accompanied by secular changes that will give a different character to the expansion. Government spending, rather than private spending, will be the primary source of aggregate demand. Attempts to “get us back to where we were” would entail policy actions that would sustain spending above the long-run trend. This will force spending, employment and fiscal deficits above the new long-run equilibrium. Higher taxes, more regulation and greater trade protectionism are not pro-growth policies, and if enacted, would offset much of the macro stimulus while also leading to distortions in economic allocation.

Inflation, Credit and Interest Rates

While we look for continued low inflation for the rest of this year, our expectations for a steeper yield curve continue to be corroborated by the market. The issue is not one of inflation but rather the twin forces of a diminishing flight-to-quality premium and rising federal deficit concerns. At the short-end of the credit markets there has been improvement in the interbank and commercial paper markets where the Federal Reserve has developed a number of specialized programs. Fed intervention in the mortgage and asset-backed securities markets has also been helpful. Yet tight credit conditions and risk aversion remain an issue for markets where the Fed intervention has been more muted. Yes, corporate bond markets have improved—however, during the recovery ahead credit will be less available and only at a higher price than in the prior expansion.

While we see the recession ending, our forecast is not optimistic. Our outlook remains at the lower end of the range of forecasts in the latest Blue Chip Economic Forecast. We do not see a consumer/housing led “V-shaped” recovery as some suggest. Instead we are sticking to a more sluggish recovery with higher, structural unemployment that will disappoint.

Published on  Wed, May 13 2009, 10:24 GMT

0

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Recovery is in the Mind of the Beholder

Wed, Apr 8 2009, 07:46 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Overview

Recovery is in the Mind of the Beholder

We continue to expect the economic recovery to start late this year. Yet we see the recovery as being different in both character (less diversified) and strength (weaker) relative to past recoveries. Therefore, we believe the recovery will be disappointing to both citizens and policymakers. Such disappointment means more difficult decisions in the next three years.

Economics is the science of choices and tradeoffs. Our outlook suggests that the recovery in output, employment and consumer incomes will be sub par, which means consumer and government spending will not return to what many would perceive as normal for an economic recovery. For example, consumer spending is expected to be down 0.7 percent in 2009 and only rise 1.2 percent in 2010. This is below the average of 2.9 percent during the 2004-2007 period. We estimate just 740,000 housing units will be started in 2010; the average during the 2003-2005 bubble period was 1.95M units. Unemployment is estimated to reach nearly 11 percent compared to about five percent during the 2004-2006 period. Historically, large budget deficits will persist, and decision-makers in both the private and public sectors will have to make hard choices on scarce resources. There is an ongoing economic adjustment to a new, lower equilibrium long-run growth rate for retail, construction, manufacturing (particularly durable goods) and financial services. This adjustment is most evident in the large, broad-based declines in recent employment data.

International Overview

Are Foreign Economies Bottoming Yet?

Most economies experienced deep contractions in the fourth quarter, but there have been some glimmers of hope recently. The Chinese manufacturing PMI recently crossed the demarcation line that separates contraction from expansion, and “hard” data in some countries show that industrial production has risen recently. However, it would be premature to claim that the global economy is “stabilizing,” which implies that activity has bottomed. Rather, it probably would be more accurate to say that an inflection point, in which activity is still declining but less rapidly than before, may have been reached. Recovery is not here yet, but recent developments are somewhat encouraging. Indeed, “a journey of one thousand miles begins with a single step.”

We believe the greenback will trend modestly higher between now and the end of 2009. U.S. policymakers have arguably done more to stimulate the economy than their counterparts in many foreign countries. The United States should show signs of exiting its deep recession before most other major economies do, and expectations of better days ahead should be positive for the greenback. However, the dollar’s rise likely will run out of steam later this year as the sluggish U.S. economic recovery that we forecast keeps rates of return on dollar assets relatively low. Moreover, strong foreign purchases of U.S. Treasury securities, which helped to boost the greenback last year, should wane as risk aversion becomes less extreme.

Published on  Wed, Apr 8 2009, 07:46 GMT

10

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Yes We Can Recover!

Wed, Mar 11 2009, 17:44 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Overview

Yes We Can Recover!

We continue to believe the fourth quarter of 2008 and the first quarter of 2009 will mark the darkest hours of this recession. Output, employment and consumer spending will likely remain under pressure for all of this year and possibly into the early part of next year. The recession will eventually end and we see the bottom occurring in either the fourth quarter of 2009 or first quarter of 2010. The end of the recession, however, will not mark the end of the economy’s struggles. The unemployment rate is expected to rise throughout 2010, peaking at 10 percent or more.

Our outlook includes the impact of the recently enacted economic stimulus act. Reductions in payroll withholding will provide some modest support to personal and after–tax income in April and May, which will help moderate recent declines in consumer spending. Business fixed investment and commercial construction are expected to be somewhat weaker than our earlier forecast, reflecting the recent sharp downturn in factory orders and business confidence. Government spending has also been revised slightly higher, particularly during the second half of this year.

Slower economic growth around the world is cutting into exports and we now expect international trade to subtract 0.6 percentage points from 2009 economic growth. The large downward revision to fourth quarter real GDP also lowered the growth trend, and we now expect real GDP in 2009 will contract 3.3 percent.

International Overview

Foreign Central Banks Join Fed in Unorthodox Steps

At recent policy meetings, the Bank of Canada, the Bank of England and the European Central Bank each cut their respective policy rates by 50 basis points. Central banks in Canada and Great Britain have cut policy rates about as low as they can go. However, foreign central banks are not out of ammunition. For example, the Bank of England announced a program of asset purchases, including purchases of government bonds, which led to a significant rally in the U.K. government bond market. Lower government bond yields should help to pull private sector borrowing costs lower as well. The Bank of Canada said that it will announce a framework for unconventional policy measures in April. The ECB likely will cut its policy rate further, and it too could eventually embark upon a course of unconventional easing.

On a trade-weighted basis, the U.S. dollar has risen about 20 percent against other major currencies since last July. In our view, the dollar’s rally has further to run because signs of economic stabilization should appear in the United States before they do in most other major economies. However, as foreign economies stop contracting later this year and early next year, most foreign currencies should stabilize as well. The currencies of many developing countries should eventually stabilize and begin to strengthen as shell-shocked investors become less risk averse and become attracted to the high returns that emerging markets currently offer.

Published on  Wed, Mar 11 2009, 17:44 GMT

0

0

We Have Seen This Movie Before

Fri, Feb 13 2009, 10:57 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Overview

We Have Seen This Movie Before

Throughout this financial crisis there have been endless comparisons between today’s environment and the 1930s. We feel a more apt comparison is the deep 1973-75 recession, a period that also dealt with an oil price shock, a housing collapse and a banking crisis. Even then these problems were global, with housing slumping not only in America but in Europe and parts of the developing world.

The early 1970s economic and geopolitical environment was remarkably similar to what we have seen recently. A weakening dollar along with a nearly 50 percent spike in oil prices led to the downturn and an abrupt end to the unprecedented housing boom, sending the financial sector reeling. Unemployment sky-rocketed and policymakers leaned heavily on monetary policy to fight the recession and promote recovery. When the recovery did arrive, it was quite treacherous, with both unemployment and inflation remaining uncomfortably high. Our most recent forecast shows a deeper and longer recession, similar to 1973-75, than we experienced in 1990 and 2001. Real final sales are expected to remain negative throughout 2009. Inventory swings and declines in imports might produce a positive GDP figure before then, but we now believe the recession will last through the end of the year while job losses and rising unemployment will carry over into next year.


International Overview

Deep Global Recession in Train

Monthly data show that most economies contracted sharply in the fourth quarter of last year. Indeed, the 7.6 percent decline in OECD industrial production in November was the sharpest year-over-year contraction ever recorded (the series begins in 1975). The synchronized downturn that occurred at the end of last year reflects the global nature of the credit crunch that froze financial markets.

There is some tentative evidence that the rate of decline in global economic activity in the first quarter may not be quite as sharp as it was in the fourth quarter of last year. That said, most major economies remain mired in deep recession at present, and economic recovery in many countries does not seem likely until the second half of the year at the earliest. Stimulative monetary and fiscal policy and declining inflation, which will help to support purchasing power, should eventually help to stabilize the global economy.

Our forecast calls for global GDP to decline 0.3 percent in 2009, which would mark the first drop in global GDP since the IMF began to compile worldwide GDP data in 1970. Although global growth should turn positive again the following year, the 2.9 percent growth rate that we project for 2010 is below the long-term growth rate of 3.6 percent per annum that global GDP growth has averaged over the past four decades.

Adjusting To The New Reality

Recent weeks have seen a flurry of activity in Washington directed at solving the financial crisis and moving the economy toward recovery. One thing is certain: there is no “silver bullet.” The recession will take time to play out and the economic stimulus package and financial sector reform efforts will take time to produce results. We have been incorporating a very large stimulus effort into our baseline forecast for the past several months. The current bill is lighter on infrastructure spending than we had thought it would be but the tax cuts are more significant than we originally expected. As result, we have slightly boosted our estimates for income growth and spending around the middle of this year. The bulk of the impact from the stimulus package will not affect the economy until late this year and early next year.

Financial reform efforts being undertaken by the government are harder to gauge right now. So much of current efforts seem to be aimed at bringing lending back to where it was previously. That is clearly not going to happen. The current recession marks the end of the era of abundant and cheap credit just as the 1973-75 recession marked the end of the era of abundant and cheap energy. Businesses, policymakers and households need to adjust to this new reality. With the securitization market still largely frozen, banks will continue to closely scrutinize anything they add to their balance sheets. Banks will lend but credit will be allocated much more cautiously, not just this year but for years into the future.

Tighter credit conditions mean that anything that is dependent upon credit for growth will continue to struggle. This includes home sales, motor vehicles sales, commercial construction, business fixed investment and even state and local governments. The credit bubble inflated demand for most of these sectors in the years leading up to this recession, and now that credit is dearer, we are enduring the bitter aftermath of that bubble.

What all this means for the economic outlook is consumer spending will remain weak throughout 2009. We do expect some improvement, however. Motor vehicle sales should gradually ramp up from their recent lows of around a 9.5 million unit pace to an 11.0 million unit pace by the end of this year, and an 11.5 million unit pace in 2010. While that marks an improvement it is still well below the nearly 17 million unit pace averaged earlier in the decade when many households were feeling flush and drew on their increased equity from rising home values.

Spending will also likely remain constrained for other goods and services, particularly discretionary purchases such as leisure and travel, and big-ticket items, like household furniture and home electronics. Consumers will gradually ratchet up spending as tax cuts boost disposable income and falling prices for gasoline and food items boost consumer buying power. Lower mortgage rates should also help as more homeowners are able to refinance to low rate long-term fixed mortgages.

Business fixed investment tumbled at nearly a 20 percent annual rate during the fourth quarter of last year, as firms struggled to realign production capacity with dramatically weaker global economic growth. We have lowered our expectations for business fixed investment in 2009, reflecting the recent trend in non-defense capital goods orders. Tighter credit conditions are also playing a role in reining in investment outlays, but the bigger problem here is simply that businesses have too much idle capacity.

Commercial construction will be much weaker this year, with all property types declining for the next 18 to 24 months. Credit conditions tightened dramatically and prices for properties will come under pressure from rising vacancy rates and loans that will soon come due.

Published on  Fri, Feb 13 2009, 10:57 GMT

11

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Worst May be Over, but We Have Long Way to Go

Wed, Jan 14 2009, 09:28 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Overview

Worst May be Over, but We Have Long Way to Go

Real economic activity fell off a cliff during the fourth quarter, producing a sharp drop in employment, output and spending. More than 1.5 million jobs were lost during the period and total hours worked plummeted at a 7.7 percent annual rate. Real GDP did not likely decline that much, as faltering demand in the U.S. cut demand for imports and thus exported a good part of U.S. weakness. We currently expect real GDP to decline at a 5.3 percent annual rate during the fourth quarter, with final sales down 4.2 percent. While GDP growth did not fall as much as had been feared, a decline of 5.3 percent is still a pretty ferocious drop and we expect declines will persist for five consecutive quarters, the longest period of consecutive declines on record.

Moreover, production cutbacks announced by the major domestic motor vehicle manufacturers, along with many transplant operations, will likely result in a much weaker start to 2009. When all is said and done, the fourth quarter of last year and the first quarter of 2009 will likely mark the darkest hours of this downturn. The Federal Reserve is expected to keep its target rate near zero for all of 2009. While we see real GDP bottoming this summer, a strong sustainable recovery is not likely to take hold until sometime in 2010. We expect the unemployment rate to eventually reach around 9.5 percent, but not until next year.

International Overview

The dollar appreciation that has occurred on balance since summer reflects in part the sharp deterioration that has occurred in the outlook for foreign economies. We project that the dollar will rally further in the foreseeable future as sharp recessions in major foreign economies lead foreign central banks to cut rates further. Hopes for an eventual recovery in the U.S. economy should also help to push the greenback higher.

However, the eventual upturn that we project for the U.S. economy will probably be quite sluggish, at least through most of 2010. Although the Fed likely will begin to raise rates once unmistakable signs of stabilization and recovery begin to emerge, the lackluster nature of the upturn should keep the pace of tightening very gradual, making prospects for sustained dollar appreciation appear questionable.

We are usually hesitant to forecast turning points in our forecasts of dollar exchange rates. But the sluggish nature of our projected U.S. recovery does not make sustained dollar appreciation appear very credible. Although the timing is very difficult to forecast, we believe the dollar will generally strengthen as long as hopes for recovery seem believable. This episode of dollar appreciation could take a few quarters to unfold. However, once the long, drawn-out nature of the U.S. economic recovery becomes obvious, the greenback will probably give up its gains and begin to depreciate.

Published on  Wed, Jan 14 2009, 09:28 GMT

24

3

A Serious Recession Has Set In

Thu, Nov 13 2008, 08:11 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Overview

A Serious Recession Has Set In

While the NBER will not likely get around to declaring when a recession began until late January or early February, there is little doubt a serious recession has set in. Real GDP declined at a modest 0.3 percent pace in the third quarter and more recent data have been decidedly more negative. Nonfarm payrolls fell 240,000 in October, following a much larger-than-initially-reported 279,000 job loss in September.

Not only has the pace of economic decline intensified but it has also broadened considerably. Both the ISM manufacturing and non-manufacturing surveys fell well-below their key break-even level of 50 in October. The pace of layoff announcements has also picked up, as has the list of firms announcing earnings disappointments.

While lending among banks has improved, the credit crunch is still abundantly evident virtually everywhere else. Underwriting criteria for home mortgages and consumer loans remain exceptionally tight and terms are far less generous than they have been anytime this decade. Lending for commercial real estate has all but dried up and the list of delayed and canceled projects has skyrocketed. Even state and local governments are scaling back.

We expect policymakers to continue to work to offset this weakness, with a new stimulus package; likely to be passed during the lame duck congressional session. The Federal Reserve will also likely cut the federal funds rate another half point, bringing it to 0.50 percent by early next year.


International Overview

Economic Policies Turn Expansionary

Most major economies likely experienced modest declines in real GDP in the third quarter, and recent data suggest that the pace of contraction has probably quickened in the current quarter. In response to the deteriorating economic situation, macroeconomic policy in many countries has turned expansionary. The Fed has cut rates by 425 basis points since last September, and major central banks have recently accelerated their own pace of monetary easing. For example, the Bank of England slashed rates by 150 basis points on November 6.

Fiscal policy has also turned expansionary. Not only is the U.S. government contemplating another fiscal stimulus package, but China, Germany and Japan have each announced their own stimulus programs. Although monetary easing and fiscal stimulus have shown up too late to prevent many economies from experiencing recession in the near term, expansionary policies should help to limit the severity of the looming global downturn.

Despite the gloomy outlook for the U.S. economy, the greenback continues to appreciate. The dollar’s strength reflects the recent deterioration in foreign economic fortunes. Looking forward, the dollar should continue to trend higher as major central banks cut rates more than the Federal Reserve. In addition, the significant narrowing in the U.S. current account deficit that likely will transpire will exert fewer headwinds on the dollar.

This Recession Has Quite a Bite to It

We have lowered our expectations for fourth quarter real GDP growth and scaled back our estimates for the following two years. The recession is now expected to be deeper and longer than previously thought and will likely rival the 1973-75 and 1981-82 downturns in terms of its severity and longevity. Real GDP is now expected to decline at a 3.6 percent annual rate in the fourth quarter and is not expected to move back into positive territory until the second half of next year.

In terms of GDP, the recession does not look all that severe. Assuming the NBER dates the start in July or August, we would have three consecutive quarterly declines producing a cumulative drop in real GDP of 1.6 percent. While that is well short of the 1973-75 and 1981-82 recessions, the bite is expected to be every bit as bad. Domestic demand, as measured by final sales to domestic purchasers, is expected to fall for five consecutive quarters, a cumulative drop of 2.4 percent. Even this drop, however, likely understates the severity of the downturn. Past recessions have seen significant downward revisions to the data and we expect the same this coming year.

Households and consumer-related businesses are more heavily affected by this recession than any other downturn since the 1981-82 recession. Job losses have accelerated in recent months and, with the pace of layoff announcements increasing, are expected to remain at problematic levels well into 2009. We now expect the unemployment rate to top out at 9.0 percent in late 2010, reaching a peak about a year after the recession ends.

Rising unemployment will keep a tight lid on consumer spending for the next several quarters. Spending would be reined in significantly if consumers only had to worry about the job and income prospects. Today, however, it is only one of several concerns. Declines in home prices and equity prices are expected to shave $9 trillion in household wealth over the next several quarters. Even using a conservative assumption of the wealth effect, this loss in wealth will slice more than $300 billion off of consumer outlays. As if this were not enough, consumer credit is also harder and more expensive to get today, which means many households will have to find a way to live within their means, whether they want to or not.

Residential construction will also continue to decline well into 2009. While building activity has already plummeted to near zero levels in many of the most problematic areas, national builders have recently ratcheted down starts in many markets that had been holding up well. Apartment construction also ground to a halt in October as many developments had trouble securing financing.

Commercial construction will likely be the next area to see a dramatic slowdown. An extremely large number of projects have been delayed or postponed recently, again victims of the credit crunch. Other areas of nonresidential construction also suddenly look less attractive. The slowing economy has caused many utilities to scale back plans for new power plants and lower energy prices have led to a cut in energy exploration and development.

State and local governments have seen a dramatic slowdown in revenues in recent months and many have had to cut programs and employment. Outlays are expected to decline throughout most of 2009.

We expect policymakers to remain busy. A stimulus package, including extended unemployment benefits, aid to state and local governments, and new dollars for infrastructure development should quickly make its way through the Congress. We also expect some sort of aid to be made available for the domestic automobile industry. The Federal Reserve will likely nudge interest rates lower at both their December and late January meetings.

Published on  Thu, Nov 13 2008, 08:11 GMT

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October 2008

Thu, Oct 9 2008, 09:12 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Overview

The Only Certainty Today Is Uncertainty

The incredible volatility in the financial markets is not only dominating the headlines but also dramatically reshaping the economic outlook. Capital is much harder to come by today for even the strongest of credits and this is already having a debilitating impact on consumer spending, business fixed investment and employment. Our near-term forecast has been slashed and a recession is now underway. We expect three consecutive quarters of declines in real GDP beginning with the third quarter of this year, which is expected to decline at a 0.7 percent annual rate.

We expect the peak-to-trough decline in real GDP to total 1.5 percent, in line with the contraction registered during the 1990-91 recession. However, we expect that final sales to consumers and businesses will drop about 3 percent, which would be the largest decline since the 1981-82 recession.

We believe consumer spending fell more than 3 percent (annualized rate) during the third quarter and expect another negative quarter in the current quarter. Most of the weakness in consumer outlays has been in big tickets items, such as cars and household durable goods. Consumers are also scaling back purchases of smaller items and services.

Given the changes to our outlook we now expect the Federal Reserve to cut interest rates further. We look for another 50 basis point rate cut at the October 29 FOMC meeting, with a final 25 basis point cut, which would take the fed funds rate to 0.75 percent, in December or January.

International Overview

Global Recession Looks Likely

Prospects for global growth have dimmed considerably over the past month as dislocations in credit markets have intensified. Indeed, most major foreign economies, including Canada, the Euro-zone, Japan and the United Kingdom each appear destined for a few quarters of negative growth as credit dislocations weigh on investment spending and as shell-shocked consumers rein in spending. Our revised forecast calls for global GDP to grow only two percent in 2009, the slowest year of growth since 1993.

Strains in credit markets, which are posing major downside risks to growth, induced major central banks (including the Fed, the ECB, the Bank of England, and the Bank of Canada) to cut rates by 50 basis points in a coordinated fashion on October 8. We look for further easing by foreign central banks. The Bank of England likely will cut rates another 150 basis points by early next year, and the ECB probably has another 75 basis points or so up its sleeve.

The greenback has strengthened recently as foreign borrowers have scrambled for dollar liquidity. Looking forward, the dollar could give up some of its recent gains when (if?) panic subsides. That said, we project that the dollar will trend higher throughout 2009 as foreign central banks continue to cut rates and as the U.S. current account deficit gets smaller. However, the situation in financial markets remains very volatile, which makes accurate forecasting nearly impossible.

Published on  Thu, Oct 9 2008, 09:12 GMT

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September 2008

Wed, Sep 10 2008, 10:08 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Overview

The next few quarters will be the most trying time for the U.S. economy in the past two decades. Our forecast has real GDP rising at a 1.9 percent pace over the next year and real final sales to domestic purchasers rising at just a 0.6 percent pace. Conditions will feel even weaker than this. Overall consumer spending is expected to decline in both the third and fourth quarters, while spending on goods should drop in three of the next four quarters.

Consumer spending is being affected by rising unemployment, slower income growth and falling home prices. The unemployment rate is now expected top out at 7.5 percent, which will further cut into income growth. Falling home prices are the source of much of this angst and housing has not bottomed out just yet, although we are beginning to see some tentative signs of stabilization.

Exports have provided an enormous boost for the economy over the past year but are now expected to slow. Global economic growth is moderating and many developed nations are likely to see declines during the coming year.

With global growth slowing, commodity prices have tumbled, which, along with stronger productivity growth, is helping curb inflationary fears. Lower inflation should keep the Fed on hold for the foreseeable future and opens the door for an ease if conditions warrant.

International Overview

The dollar has appreciated significantly and broadly since mid-July. Does the dollar’s newfound strength reflect a better assessment of the U.S. economy? Not really. The greenback has strengthened versus many foreign currencies because the outlook for foreign economic growth has deteriorated faster than many investors had anticipated earlier this year. Signs of slowing growth in Australia led the Reserve Bank of Australia to cut rates earlier this month for the first time since December 2001. The European Central Bank and the Bank of England have not cut rates over the past few months due to concerns about inflation. Indeed, the ECB hiked rates in July. However, growth rates in the Euro-zone and the United Kingdom have slowed sharply (Great Britain will probably experience its first recession since the early 1990s), which should cause inflation to recede in the months ahead. In our view, it is only a matter of time before both central banks cut rates.

The greenback has risen very sharply in a relatively short period of time, so some retracement is bound to happen. That said, we project the dollar will trend higher versus most currencies in the quarters ahead. Although we do not expect the Fed to cut rates further, we look for foreign central banks, most notably the ECB and the Bank of England to ease policy going forward.

Published on  Wed, Sep 10 2008, 10:08 GMT

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Has The U.S. Come Down With German Disease?

Wed, Aug 6 2008, 16:37 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Overview

Has The U.S. Come Down With German Disease?

Much of the benefit from the economic stimulus checks was siphoned away by higher energy prices during the early summer months. As a result, most of the benefit from the rebate checks showed up in the May consumer spending figures. Spending weakened in June, particularly for big-ticket discretionary items. Motor vehicle sales declined even further in July, hitting their lowest level in 15 years. The net result should be an outright decline in consumer spending during the third quarter, marking the first drop in 18 years. We expect another drop in the fourth quarter.

Energy prices finally broke in late July and the national average for regular gasoline could be close to $3.50 a gallon by Labor Day. Reduced energy prices will not produce an immediate rebound in consumer outlays but should moderate the recent drop. Motor vehicle sales will remain weak through year-end and the Fed will remain on hold.

Overall GDP growth should slow during the second half of 2008 but remain in positive territory. Weak consumer spending is leading to a dramatic slowing in imports, while production cuts at major auto producers and other manufacturers have led to a sharp slowdown in inventories. Inventories liquidation subtracted 1.8 percentage points off second quarter GDP growth. That pace will not be maintained in the second half of 2008, which will provide downside protection to the overall economy

International Overview

High-Yielding Currencies Strengthened Recently

Although a broad measure of the dollar’s value has been rather stable over the past few months, there are some interesting developments occurring beneath the surface. Namely, the U.S. dollar has weakened against some emerging market currencies but the greenback has strengthened a bit vis-à-vis most major currencies.

Central banks in many developing countries have hiked rates recently in response to rising rates of CPI inflation. Not only are interest rates in these countries above comparable rates in most major economies, but they have gotten higher. Currency appreciation in these economies likely reflects flows of speculative money in search of higher returns. The greenback will probably depreciate further versus these high-yielding currencies, at least in the near term.

In contrast, interest rates in many major economies are not especially high nor are they expected to rise further. Although the ECB hiked rates by 25 basis points in July, recent signs of sharply slowing growth in the Euro-zone have led investors to scale back expectations of further tightening. The U.K. economy may be slipping into recession, which should open the door to easing by the Bank of England. That said, the greenback could grind higher versus many major currencies, a significant dollar rally probably awaits Fed tightening, which likely will not occur for some time.


Published on  Wed, Aug 6 2008, 16:37 GMT

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Sub−Par Growth: Economic Workout Continues

Thu, Jul 10 2008, 08:14 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Overview

Sub-Par Growth: Economic Workout Continues

Once again, we are faced with the hard reality that the economic workout continues, keeping pressure on profits and household incomes. There is no easy-out for the economy. We expect continued weakness in consumer spending, residential investment and capital spending in the second half of this year. In contrast, government spending and net exports should maintain positive momentum. Overall, our expectation is that real final sales will slow in 2008 and again in 2009 from the 2007 pace of 2.5 percent.

Inflation, measured by the core PCE deflator, remains at the top end of the Fed’s perceived target range. Higher priced imports, energy and food are all adding to the upward momentum in prices. This combination of sub-par growth and persistent inflation suggests that the Fed will keep the funds rate on hold through the rest of this year. Finally, sub-par growth coupled with rising input prices should deliver a decline in pre-tax profits for the second half of this year.

Our forecast has changed modestly over the past month. Estimates for 2009 have been lowered, reflecting more modest growth in consumer spending, a deeper pullback in commercial construction, and less growth in exports. In addition, the BEA will revise the GDP data for the past three years later this month, which may lower the trajectory of economic growth.


International Overview

U.S. Slowdown Spreading to Other Countries

The slowdown in the United States appears to be spreading to other economies. U.K. economic activity is the weakest it has been since 2001, and growth in the Euro-zone seems to have slowed significantly in the second quarter. Even developing countries, which have enjoyed rapid growth over the past few years, have not been immune to the slowdown. Why has growth slowed abroad? First, exports to the United States from many countries have weakened. Second, credit market dislocations have weakened growth in countries that are extensively financed via capital markets and/or experienced significant run-ups in house prices. Third, the sharp rise in the price of oil is eating into real income in many countries, effectively slowing consumer spending. Finally, foreign central banks have tightened monetary policy in response to rising inflation, engendered by the sharp rise in the price of oil. We have marked down our global growth forecasts for the rest of this year and 2009, which likely will see the slowest year for global growth since 2002. If there is a silver lining, it is that inflation in many countries should come down going forward. Indeed, core rates of inflation in most countries are lower than overall rates at present If oil prices stabilize overall rates of inflation should come back down to the core rates in the quarters ahead. Consequently, central banks in most major economies likely will refrain from tightening further.

Sub-Par Growth: Consumer and Business Restraint

Consumer spending is expected to remain weak after the initial stimulus from the tax rebates. Real personal income growth has slowed this year relative to the prior two years as inflation has picked up while job growth has turned negative. Slower real income growth, combined with losses in real estate and financial wealth have dragged consumer confidence down and should hold consumer spending to just a 1.8 percent pace this year compared to 2.9 percent in 2007.

Over the second half of the year, much of consumer spending will be concentrated in core needs and non-discretionary items. Consumer spending on discretionary items will likely remain pressured. While the tax rebates may help sustain spending short term, we expect an outright decline in real consumer spending in the fourth quarter once those checks are spent.Weakness is also the story for business fixed investment. For the second half of this year we anticipate the combination of slower top line revenue expectations, tighter credit, and reduced corporate profits will lead to slower capital spending on equipment and software. Spending on structures is expected to slow significantly. This weakness will be in contrast to the solid gains we have seen in investment during the prior three years.

Housing Continues to Struggle

On the downside, residential construction likely declined at over a 20 percent annual rate in the first half of this year and is expected to continue to decline at a double-digit pace in the second half. The fundamentals remain negative. Housing demand is limited by sluggish income growth, low consumer confidence, tighter lending standards and a prevailing concern about further price declines. On the supply side, the inventory of homes remains large relative to the pace of sales in many areas. Lower interest rates and falling home prices have led to an increase in housing affordability. However the concerns of buyers and creditors have kept many on the sidelines.

Trade remains a big positive in the economy. We anticipate trade will add one-half of one percent to growth for the second half of 2008. The weaker dollar and stronger growth abroad are the key drivers. Inflation has heated up considerably abroad, however, and central banks, particularly in emerging markets, are beginning to hike interest rates.

Profits Weak & Interest Rates Flat

Pre-tax profits are expected to decline about six percent in 2008 compared to a gain of 2.7 percent in 2007 and 13.2 percent two years ago. The downturn in profits is consistent with slower top line revenue as well as higher input costs signaled by manufacturer surveys and commodity indices.

Short-term rates are likely to remain range-bound as the Federal Reserve balances the dual challenge of below-trend economic growth and above-target inflation. Long-term rates are expected to drift upward once calm returns to the financial markets. Concerns about the dollar and further Treasury financing needs are likely to limit any Treasury rallies despite continued soft economic news.

Credit spreads are not expected to narrow, as event risk remains a concern for investors. Capital markets continue to search for a new risk/reward tradeoff. At present, the trend in the TED spread (three month futures contract for U.S. Treasuries less the three month Eurodollar futures contract) suggests the new equilibrium spread will remain higher than where it had been during the 2004-2006 period. Risk is being priced back into the fixed income market, but the market is still determining what the equilibrium price will be.

Published on  Thu, Jul 10 2008, 08:14 GMT

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Sub−Par Growth: Economic Workout Continues

Wed, Jun 11 2008, 10:44 GMT
by Wachovia Research Team

Wells Fargo Investments, LLC


U.S. Overview

Sub-Par Growth: Economic Workout Continues

Our outlook remains for sub-par growth with weakness continuing in consumer spending, residential investment and capital spending for the second half of this year. In contrast, government and net exports should continue their positive momentum. Overall, our expectation is that real final sales will grow at only one percent in the second half of this year compared to 2.5 percent for all of 2007. Inflation, as measured by the core PCE deflator, remains at the top end of the Fed’s perceived target range as import prices, energy and food add to the upward momentum in prices. This combination of sub-par growth and persistent inflation suggests that the Federal Reserve keeps the funds rate on hold through the rest of this year. Finally, sub-par growth coupled with rising input prices will drive weaker pre-tax profits for the rest of this year.

Sub-Par Growth: Consumer and Business Restraint

Consumer spending is expected to remain weak after the initial stimulus of the rebate checks. Real personal income growth has slowed this year relative to the prior two years as inflation has picked up while job growth has turned negative. Lower real income growth, combined with losses in real estate wealth and diminished consumer confidence combine to generate consumption of just 1.6 percent for 2008 compared to 2.9 percent last year.


International Overview

Long-term interest rates in most major economies have moved up sharply in the last week or two as central bankers have turned hawkish. The surge in energy and food prices has had only limited effects on core rates of inflation so far. However, central bankers appear determined to avoid a replay of the 1970s when sharp increases in energy prices led to generalized acceleration in most other consumer prices. Credit market dislocations and forecasts of slower growth had led investors to anticipate ECB easing by the end of the year. However, the ECB has refrained from cutting rates, and it now looks like it will raise rates by the end of the year to keep inflation expectations contained. Although the Bank of England will probably cut rates again before the end of the year, the recent rise in CPI inflation makes a significant amount of easing less likely. Changes in our interest rate outlook have some implications for our exchange rate forecasts. We had projected the dollar would begin to strengthen versus the euro in the third quarter of this year as investors began to anticipate Fed rate hikes. With rates heading higher in the Euro-zone and not rising as fast in the United States as we had originally projected, the dollar will likely continue to struggle versus the euro in the near term. Although the euro could easily test its all-time highs, we do not believe a sharp decline in the dollar is likely. U.S. officials have recently hinted at the possibility of foreign exchange market intervention, which would give the greenback some support if it came under selling pressure.

Published on  Wed, Jun 11 2008, 10:44 GMT

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It is still premature to be optimist

Thu, May 8 2008, 08:26 GMT
by Wachovia Corp. Economics Group

Wells Fargo Investments, LLC


U.S. Overview

Our forecast is now slightly more optimistic than it was a month earlier. We are no longer looking for real GDP to decline during the second quarter and also expect the economy to eke out modest gains for the year as a whole. Our slightly more optimistic take on the near-term economic environment should not be confused with optimism about the overall state of the economy. Growth is almost entirely being driven by improvement in the trade deficit and modest gains in government outlays. Private domestic demand has already fallen more than it did in the 2001 recession and will likely fall more this year than any other time since the deep 1981-82 recession.

Consumer spending is now expected to hold up slightly better this spring, thanks largely to the accelerated pay-out of the tax rebates. While there has been considerable discussion about how much of the $110 billion tax rebate will be spent, we expect at least two-thirds of the rebate to be spent over the next three to four months. Most of this increase will likely show up in the third quarter GDP figures, when we expect consumer spending to climb at a 4.2 percent pace.

The rebound in consumer spending will cause inventories to decline in both the second and third quarters, which will restrain the overall rise in real GDP. With inventories already lean, however, production will likely bounce back later this year and into 2009.


International Overview

The dollar has strengthened over the past few weeks, and some analysts are proclaiming the bottom is in now. In our view, however, it is still premature to look for dollar appreciation on a sustained basis. As long as investors question the extent of the U.S. economic slowdown and the corresponding outlook for Fed policy, the greenback should move largely sideways against most major currencies.

That said, the fundamentals are starting to move back in favor of the dollar. The good news is the current account deficit is getting smaller because real exports of goods and services are growing significantly faster than imports. If oil prices ever come down, the current account deficit will get significantly smaller. However, capital inflows have weakened over the past year as markets for structured fixed income products have shut down. Until these markets open again and/or U.S. interest rates begin to rise, sustained dollar appreciation does not seem likely.

If our macro U.S. forecast is realized, however, it will become apparent later this summer the Fed’s easing cycle has indeed ended. As investors begin to anticipate eventual Fed tightening the greenback should start to strengthen versus most major currencies, especially vis-à-vis the euro. However, the dollar likely will continue to weaken against most currencies in developing Asia. Governments in the region use the exchange rate as an instrument of economic policy and currency appreciation helps to constrain the biggest economic problem in the region: inflation.


Published on  Thu, May 8 2008, 08:26 GMT

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Domestic Demand Is Much Weaker Than GDP

Thu, Apr 10 2008, 09:15 GMT
by Wachovia Corp. Economics Group

Wells Fargo Investments, LLC


U.S. Overview

Now that nonfarm employment has declined for three straight months, virtually all economists have conceded the U.S. economy is in recession. Ironically, the data are not nearly as accommodating. First quarter real GDP will likely be slightly positive, rising at a 0.6 percent pace. We do see real GDP slipping into negative territory during the second quarter, but only modestly, falling at a 0.7 percent pace.

We have often noted that economics is just common sense made difficult and our common sense tells us there is more pain in the economy than is evident in current economic data. We expect the weakest period for the economy will be in the first half of this year.

We continue to believe domestic demand will remain much weaker than overall GDP, which is a point we made in prior outlooks. We project real final sales to domestic purchasers to be flat in the first quarter, decline sharply in the second and rise just 0.4 percent for all of 2008. By contrast, real GDP will likely post only one quarterly drop and rise 1.3 percent for the year.

The Federal Reserve began to ease well ahead of any actual weak economic reports and will likely stop cutting interest rates before the recent run of bad economic news ends. We expect one more quarter point cut in the federal funds rate at the April 29/30 FOMC meeting and then look for the Fed to wait and see the impacts of previous policy moves and the tax rebates, which will begin to arrive in May.

Published on  Thu, Apr 10 2008, 09:15 GMT

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The resiliency of the U.S. economy continues to astound market commentators

Wed, Nov 7 2007, 17:30 GMT
by Wachovia Corp. Economics Group

Wells Fargo Investments, LLC


The resiliency of the U.S. economy continues to astound market commentators, many of whom are relentlessly focusing on what is going wrong in the economy and ignoring what is doing well. Real GDP expanded at a 3.9 percent pace in the third quarter and is up 2.6 percent over the past year. To be honest, it certainly does not feel like the economy is growing this fast. We do not question the validity of the GDP numbers, however. The reason the economy does not feel this strong is that there is a growing divergence between domestic demand and real GDP.

We have repeatedly noted the emergence of the split between gross domestic demand and real GDP in our monthly outlooks. Housing and consumer spending, two areas that most households readily identify with, are clearly slowing, while exports are surging. This best illustration of this point is that exports have more than made up for the decline in residential construction since homebuilding began to slide at the tail-end of 2005. The trade deficit is shrinking. The improvement in net exports added 1.3 percentage points to second quarter growth and a full percentage point to growth in the third quarter.

We are looking for continued improvement in the trade deficit but expect the quarterly improvement to be much less than what we have seen in the past two quarters. The improvement in trade will help offset the continued slump in homebuilding, which will remain a significant drag on GDP growth through at least the middle of 2008.

The dollar continues to trend lower, which reflects the interplay between the current account deficit and the long-term capital inflows that help to finance it. Although the current account deficit is getting smaller, the greenback faces a number of headwinds.

First, recent dislocations in credit markets have significantly diminished new issuance in structured fixed income product markets, which gives foreign investors fewer U.S. securities to purchase. Second, interest rate differentials are not helping the dollar at present. The Fed has been cutting rates, but other major central banks are either on hold or about to tighten further. Finally, the trend decline in the value of the dollar, which has been in place for nearly six years, gives foreign investors little reason to expect a turnaround anytime soon. Why buy an asset if you think its price will decline further? In our view, these headwinds likely will continue to buffet the dollar for the foreseeable future.

The bottom line is that the trend decline in the value of the dollar likely has further to run. Although a short-term correction is bound to happen sooner or later, we project that the greenback will trend lower until the end of next year. We are usually reluctant to project future turning points in exchange rates. However, our forecast calls for the Fed to tighten policy anew in 2009 as U.S. economic growth strengthens. Under that scenario, the dollar should appreciate versus most major currencies in 2009.

Published on  Wed, Nov 7 2007, 17:30 GMT

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We continue to struggle to balance near−term concerns about events in the credit markets

Thu, Sep 13 2007, 10:04 GMT
by Wachovia Corp. Economics Group

Wells Fargo Investments, LLC


We continue to struggle to balance near-term concerns about events in the credit markets with the most recent economic data, which have mostly come in ahead of expectations. The one notable exception is the August nonfarm employment data, which posted a surprising 4K job loss in August. The drop has rekindled fears that the faltering market for new and existing homes will trigger cutbacks in consumer spending and business fixed investment. Talk of a recession has also resurfaced, although we feel such talk is premature.

Our forecast has been scaled back slightly over the next three quarters, as we incorporate more conservative assumptions about consumer spending and business fixed investment. We have also steepened the decline in residential construction and slightly scaled back our forecast for state and local government spending.

While our forecast has been reduced slightly, we still see a generally improving trend in overall economic activity. The mix of growth will be much more heavily weighted toward gains in business fixed investment and net exports. Consumer spending will grow at a pace well-below income gains, which means the saving rate will rebound modestly.

The Federal Reserve is expected to cut short-term interest rates by a quarter-percentage point at both its September 18 and October 31 FOMC meetings. The move is designed to prevent the weakness in the housing market from spreading to other parts of the economy.

The dollar has depreciated recently, hitting multi-year or all-time lows versus many major currencies. Why? For starters, the U.S. current account deficit, although showing signs of narrowing a bit, remains very large. In order to keep the greenback stable, net capital inflows totaling about $3 billion per business day must enter the country. That is a very tall order indeed.

Unfortunately for the dollar, interest rate differentials have moved against it, which has eroded the relative attractiveness of U.S. assets. The Federal Reserve likely will cut interest rates in the months ahead. Although recent dislocations in credit markets have caused foreign central banks to shelve plans to tighten further, they likely will not be easing policy, at least not for the foreseeable future. Looking forward, we project that the greenback will continue to trend lower vis-à-vis most major currencies.

Could the slowdown that is underway in the United States lead to a global recession? After all, the common perception is that the U.S. economy is largely responsible for much of the growth in the world. This perception, which may have been roughly accurate a decade ago, is less true today. Over the past few years, the U.S. economy has accounted for only 15 percent of global growth. Although the rest of the world would certainly feel the effects of a sharp U.S. slowdown, should one occur, the probability of a global recession at present is rather low.

Published on  Thu, Sep 13 2007, 10:04 GMT

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Second quarter economic growth will likely bounce back at around a 3.5 percent pace

Thu, Jul 19 2007, 07:33 GMT
by Wachovia Corp. Economics Group

Wells Fargo Investments, LLC


Second quarter economic growth will likely bounce back at around a 3.5 percent pace, reflecting a turnaround in business inventories and international trade, along with some modest improvement in business fixed investment. Meanwhile, consumer spending cooled off considerably during the second quarter. Sharply higher gasoline prices, rising mortgage rates and the reduced pace of home price appreciation all served to limit spending power.

Risks to the economy and financial markets have clearly increased. We continue to believe there will be very little spillover from the unwinding of the housing boom and troubles in the subprime lending market to the rest of the economy. Although, there will be some spillover. The key question now is how lenders and regulators respond. An overzealous response could trigger a credit contraction resulting in another down leg to the housing market and overall growth. We still feel we will avoid that outcome.

The more likely course of action is that the speculative excesses of the housing boom will be allowed to run their course. Foreclosures will rise, home prices will correct, and affordability will gradually improve. We do not expect a return to the conditions that existed at the height of the housing boom anymore than we expect the NASDAQ to retest its all-time highs. Home sales and new construction should level off, however, allowing for overall growth to gradually strengthen. We doubt that the Fed will do anything to short-term interest rates until they see some definitive signs that the housing market has bottomed.

Coming into this year we and most other forecasters projected that growth in many foreign economies would slow in 2007. With half of the year already on the books, it seems that we were a bit off the mark. Indeed, growth in many foreign economies has held up better than most forecasters had anticipated. Not only have relatively low interest rates helped to buoy growth, but the long-run process of globalization, which raises real income via better economic efficiency, is also providing an ongoing lift to global economic growth.

There are some implications of strong global growth. First, strong economic growth generates robust demand for commodities, which helps to underpin prices of key raw materials. In addition, central banks in many foreign economies continue to raise rates to ensure that growth does not become strong enough to lead to rising inflation. The Federal Reserve has been on hold for the last year, however, and interest rate differentials between the United States and the rest of the world have narrowed, thereby eroding the relative attractiveness of U.S. assets.

Looking ahead, we expect that the dollar will continue to depreciate versus most major currencies. Sooner or later, however, the greenback will start to appreciate again. In our view, the catalyst for dollar appreciation will be renewed tightening by the Federal Reserve that we project will start in mid-2008. In the meantime, we project the greenback will continue to trend lower versus most major currencies.

After The 2nd Quarter Bounce Look For Growth to Cool

Our forecast has not changed materially over the past month. We were looking for second quarter real GDP growth to be 3.5 percent then and we still expect a gain of that magnitude. Beneath the surface, however, the tone has changed slightly. The second quarter appears to have ended on a soft note, particularly consumer spending. Home sales and new construction also likely weakened a bit further in June, as mortgage rates spiked last month. We have slightly reduced our growth estimate for the second half of the year and the risks are to the downside.

Interpreting the monthly data releases will take a little more patience and diligence. Most of the data covering the consumer and housing will likely remain weak. Real after-tax income declined slightly during the second quarter, as wages and salaries had difficulty keeping pace with soaring gasoline prices and higher taxes. Prices are also rising a bit more at the grocery store, leaving consumers with less money to spend on everything else.

In addition, home sales are still declining. The nation’s largest home builders have generally reported disappointing traffic through model homes and a few have lowered their earnings guidance and announced large write-downs. The National Association of Realtors’ pending home sales index has posted large back-to-back declines in April and May. We continue to believe that home sales, both new and existing, will bottom out in the next few months and find ourselves constantly reminding folks that the data typically looks the absolute worst at the market bottom.

Even if sales bottom out this summer, new construction still appears set for further declines. Inventories of new and existing homes remain too high and will take at least a year to 18 months to correct to levels close to their long-term norms. We do not expect housing starts to bottom until late this year and look for housing completions to bottom out next spring.

With consumer spending growing more slowly and residential construction continuing to decline, the economy will need stronger gains from business fixed investment and some improvement in international trade for the expansion to continue. Fortunately, improvement is now evident on both fronts.

Business fixed investment started the year in a huge hole. Shipments of heavy trucks collapsed as a new EPA mandate on diesel engines took effect on January 1. Ford and General Motors both slashed production capacity, reducing demand for industrial equipment. Both companies also reduced sales to rental car companies, further eating into capital spending. Homebuilders have also cut back on equipment purchases.

Orders and shipments of capital goods picked up in March and April and the ISM index and regional purchasing managers’ surveys all suggest that investment spending has turned more positive. The bounce back we expect in the second quarter should not be over interpreted. Businesses remain cautious and will likely remain unusually judicious in expanding capacity.

There are some notable areas of strength. Spending for energy production has clearly increased, and investment in biofuels is booming. IT spending has improved as new handheld technologies have led to increased demand for data transmission and storage capacity. All of the growth in the agricultural sector has also boosted capital outlays, as has the success of Boeing’s new 787 Dreamliner, which has racked up a huge backlog of mostly export orders.

The nation’s enormous trade deficit is beginning to show some signs of improving. Slower consumer spending should cut into demand for imports, while a weaker dollar will boost the competitive position of U.S. producers. The weaker dollar is also encouraging a wave of foreign direct investment, resulting in new multi-billion dollar steel mills, pharmaceutical plants, and motor vehicle assembly plants.

Published on  Thu, Jul 19 2007, 07:33 GMT

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Economic Workout Continues

Thu, Jun 7 2007, 08:55 GMT
by Wachovia Corp. Economics Group

Wells Fargo Investments, LLC


Economic growth is now widely expected to bounce back solidly from the tepid 0.6 percent pace posted during the first quarter. A consensus seems to be building around real GDP growth rising in the 3 percent range during the current quarter. We see economic activity expanding at a slightly faster rate, with output climbing at a 3.5 percent pace.

The improved economic outlook largely results from a couple of strong reports on factory orders, particularly for nondefense capital goods, and much stronger reports from the national and various regional purchasing managers’ surveys. In addition, consumer confidence is holding up better than expected, consumer spending remains solid, and the employment data have strengthened.

The economy’s apparent abrupt turnaround has raised inflation fears and dampened expectations of lower interest rates. Several large investment banks have dramatically increased their forecasts for second quarter growth and many have taken rate cuts out of their near-term forecast.

We have had the Fed on hold for quite some time and most of the changes made to our current forecast merely incorporate the latest revisions to first quarter data. First quarter GDP was revised down 0.7 percentage points, mostly due to a larger drawdown in inventories. Our forecast for second quarter real GDP has been raised by a like amount and now shows output expanding at a 3.5 percent pace. From our perspective, the outlook has not changed all that much. What has changed is Wall Street’s perception of how strong the economy actually is.

After depreciating for most of the year, the dollar has stabilized versus most major currencies over the past month or so. Stronger-than-expected U.S. economic data have poured cold water on the notion that the FOMC would cut rates this year. Interest rate differentials, however, have not yet moved back in the dollar’s favor because most foreign central banks have been hiking rates. Although inflation rates in most foreign economies generally remain benign, foreign policymakers want to take pre-emptive steps to ensure that inflation remains under control.

The narrowing in interest rate differentials between the United States and the rest of the world that has occurred this year has eroded the relative attractiveness of U.S. assets, leading to a weakening in net capital inflows. Not only have foreign investors reduced their purchases of U.S. assets somewhat, but domestic investors have become more interested in buying foreign securities as rates of return abroad have risen.

Looking forward, we continue to project that the dollar will trend lower versus most currencies over the next few quarters. In our view, interest rate differentials need to swing back in favor of dollar assets before the greenback can start to trend upward again. Although the Fed may not cut rates this year, it likely will not be hiking rates anytime soon either. Looking much further ahead, we project that the dollar will begin to strengthen in the second half of next year as the Federal Reserve begins to tighten anew. To reiterate, however, we believe that the dollar will depreciate further before it starts to appreciate on a sustained basis.

The Economy Appears Set To Spring Forward

Given all the talk about weakness in the housing market, the woes in the sub-prime mortgage market, and the downward adjustment to first quarter real GDP growth to a tepid 0.6 percent annual rate, many people might find it surprising that economic activity could bounce back so solidly in the current quarter. Our forecast for 3.5 percent growth would end a string of four consecutive quarters of below trend growth and would mark the strongest quarterly growth rate since the first quarter of last year.

While we have a high degree of confidence in our forecast, we do not believe that economic activity has heated up as much as the headline numbers suggest. Simply averaging our estimate of second quarter growth along with the first quarter’s 0.6 percent gain yields a 2.1 percent pace for the first half of this year. That pace is roughly equal to what has been seen over the past year.

Most of the improvement in second quarter GDP simply results from a bounce back in some of the things that were unusually depressed in the first quarter. Other areas, such as housing and international trade, which were big drags on first quarter growth, are expected to be less of a problem in the current quarter.

Business inventories, which subtracted 0.9 percentage points off first quarter GDP growth and sliced 1.1 percentage points off fourth quarter growth, are one area primed for a bounce back. We are looking for a modest rebound in the current quarter, with inventories rising by $12.4 billion and adding 0.6 percentage points to growth.

Another area where activity is bouncing back is business fixed investment. Outlays for equipment and software eked out a 2.0 percent annualized gain in the first quarter, following a 4.8 percent drop the previous quarter. All the first quarter’s gain was in IT equipment and software, which soared at an 18.7 percent annual rate. By contrast, investment in other business equipment plunged at a 17.9 percent pace, as heavy truck sales continued to suffer from a new EPA mandate on diesel engines. Rental car fleet purchases were also smaller this year, as the big domestic auto producers decided not to go after that market.

More recent data suggest business investment has picked up. Orders for nondefense capital goods, excluding aircraft, rose 4.6 percent in March and an additional 2.1 percent in April. Moreover, the new orders component of the Chicago Purchasing Managers’ survey leapt 14.6 points to 71.1 in May, and several other regional indices posted similar gains. The national ISM survey rose more modestly, climbing 0.3 points to 55.0 in May. The new orders series rose 1.1 points to 59.6.

The improvement in the purchasing managers’ surveys bodes well for the upcoming data on May factory orders and shipments. Even a modest improvement in the May numbers would just about insure that business fixed investment will rise at around a seven percent pace, which is what we are projecting for the second quarter.

The rise in the ISM survey and regional purchasing managers’ surveys may be giving off an impression of a more lasting improvement than we can count on just yet. Remember that these surveys are diffusion indexes and tell us more about the timing and breadth of any improvement in the economy than they do about the magnitude. The most recent improvement follows a string of weaker numbers late last year and earlier this year. We expect the purchasing managers’ surveys, new orders and investment outlays to fall back a little bit in coming months, which should help cool off some of the inflation concerns that have sprung up recently.

The inflation data have improved and will likely continue to do so this summer. While higher gasoline prices remain a risk, there is a growing probability most of the damage is behind us. We are beginning to see some moderation in housing costs, which should help contain core inflation. The core PCE deflator should remain near the top end of the Fed’s comfort zone, which should allow the Fed to hold rates steady in 2007. Better news on inflation should also help contain the carnage in the bond market.

Published on  Thu, Jun 7 2007, 08:55 GMT

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Economic Workout Continues

Thu, May 10 2007, 08:38 GMT
by Wachovia Corp. Economics Group

Wells Fargo Investments, LLC


For sometime now decision–makers have faced the undynamic duo of below trend growth and above target inflation. During the typical mid-cycle of an economic expansion, slower growth is not unusual, but what is unusual is the length of the current period of below trend growth. Higher inflation is also not unusual, but this time the pace of inflation remains above the Federal Reserve’s target ceiling and that closes the door on any easing unless the economy weakens even more. Without above trend growth or looser monetary policy, we have seen firms turn to rationalization and restructuring the business to provide efficiency gains and get prepared for stronger growth next year.

Looking ahead, the second half of this year should benefit from modest consumer spending along with a modest recovery in business investment. Government spending continues to profit from strong tax revenue growth based on strong income gains. Net exports are expected to contribute positively to growth as well. Real GDP is expected to be up 2.3 percent this year compared to 3.3 percent last year.

What is the downside risk to the economy? The depth and duration of the correction continues in the housing sector. We expect the bulk of the decline in residential construction to be behind us by the end of this year, as housing continues to be a drag on overall growth. The inverted yield curve remains a challenge to depository institutions.

The dollar recently fell to a 25-year low against sterling and its all-time low vis-à-vis the euro. However, there is less to the recent decline of the greenback than meets the eye. On a real trade-weighted basis, the greenback has dropped only about half as much as it did during the last extended period of dollar weakness in the mid-80’s. Not only have inflation rates in many developing countries been lower than in the U.S., but governments in many of these countries have actively limited the appreciation of their currencies.

Indeed, we project that the greenback will trend lower over the next few quarters due to unchanging fundamentals. For starters, the current account deficit remains very large, which will continue to exert downward pressure on the greenback. In addition, the relative attractiveness of dollar assets is being eroded, which is leading to weaker net capital inflows. The Fed has been on hold for nearly a year, but other major central banks, including the European Central Bank and the Bank of England, continue to tighten policy. We do not see the fundamentals coming to the dollar’s rescue anytime soon.

Looking further ahead, however, we could see a case for a dollar turnaround late next year if, as we project, the Fed begins to raise rates again. However, we would caution that this projection of a dollar turnaround is very uncertain. The second half of next year is a very long time from now, and the economic outlook could change significantly between now and then. In addition, we believe the dollar will decline further before it begins to appreciate again on a sustained basis.

Housing market adjustments differ significantly by region and metro area across the nation. We expect corporate profit growth has also slowed, thereby weakening investment spending. Slower top line revenue growth and rising unit labor costs suggest that profit growth will remain single-digits this year. Our outlook remains that the Federal Reserve will hold interest rates steady this year.

Economic Workout Continues

Mid-cycle expansions are periods of adjustment and correction. The economy continues to work through its overspending on housing as well as secular shifts in the auto industry and population. During the first half of 2007, housing should remain a significant drag on the economy. Real GDP is expected to grow two percent during the first half of the year and a bit stronger in the second half, as the negative growth implications of housing diminish. Unfortunately, we do not expect core inflation to moderate, as rising labor compensation costs and declining productivity, both typical of the mid-cycle economy, conspire to keep inflation above the Fed’s target ceiling.

Domestic Demand

Consumer spending growth should benefit from continued real income gains and the improvement in consumer psychology due to a tight labor market. On the downside real incomes will be reduced by the higher price of gasoline at the pump. Employment and income growth should remain relatively solid. After expanding at 3.2 percent last year we expect personal consumption expenditures (PCE) to rise just over three percent again this year. Spending for motor vehicles and other big-ticket items is expected to moderate over the course of 2007, which should help push the saving rate up from its record lows hit this past year.

Business fixed investment weakened sharply at the end of 2006 especially equipment and software spending. Two fundamentals—slower final sales growth and reduced corporate profit growth—do suggest slower investment in 2007. On the plus side, however, capacity utilization and capital costs remain favorable. In recent quarters, the weakness in business equipment spending does appear to have declined more than fundamentals suggest. A recovery in capital spending should be signaled by a pickup in new orders and shipments of non-defense capital goods ex-aircraft in the months ahead.

Government spending will also provide a slight boost to overall growth in the coming year. State and local government budgets have improved dramatically over the past year. Many have held back on major infrastructure projects due to sharply higher construction costs. With costs having moderated in recent months, many projects will now likely move forward.

Overlooked in all the pessimism about housing is the strength of export demand and the likely positive add to growth from net exports. In 2005 and 2006, net exports weighed on growth.

Interest Rates and Credit Risks

Slower economic and profit growth, along with the slide in the housing market, indicate a higher risk profile for creditors. Credit spreads have widened and delinquencies on sub prime mortgages have surged in recent months. However, given the above target pace of inflation, we do not expect any Fed easing this year. This leaves us with a flat-to-inverted yield curve all year. So far, there has been little overt tightening in lending standards by private banks, yet some tightening is clearly coming. Tighter lending standards will shrink the availability of mortgage and business lending credit, which will moderate any gains in housing and business investment this year. We remain cautious on the credit front this year with the bias that credit issues could limit the pace of the recovery.

Published on  Thu, May 10 2007, 08:38 GMT

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Challenges: Below Trend Growth, Above Target Inflation

Thu, Apr 12 2007, 08:55 GMT
by Wachovia Corp. Economics Group

Wells Fargo Investments, LLC


For decision–makers the fraternal twin challenges of below trend growth and above target inflation suggest a strategy of caution and balance sheet repair at this stage of the business cycle. During the typical mid-cycle of an economic expansion, slower growth is not unusual, but what is unusual is the length of the current period of below trend growth. Higher inflation is also not unusual, but this time the pace of inflation remains above the Federal Reserve’s target ceiling and that closes the door on any easing unless the economy weakens even more. Challenges remain.

U.S. economic growth should benefit from modest gains in consumer spending although such gains have been limited by the weaker housing market and cutbacks in the domestic motor vehicle industry. Corporate profit growth has also slowed, thereby, weakening investment spending.

Government spending continues to benefit from tax revenues based on strong income gains. Net exports are expected to contribute positively to growth in 2007 as well. Real GDP is expected to be up 2.3 percent this year compared to 3.3 percent last year.

The major downside risk to the economy continues to be the housing sector. We expect the bulk of the decline in residential construction to be behind us by the middle of this year. In addition, inventories should be a drag on growth all year. Interest rates and the inverted yield curve will limit growth. As such, the Federal Reserve will likely hold interest rates steady this year.

Foreign Economic Growth Remains Solid

Recent data suggest economic growth in the rest of the world has slowed somewhat over the past few months, but growth rates generally remain solid. Not only is monetary policy in most foreign countries not overly restrictive yet, but the forces of globalization are helping to lift real income in many emerging economies.

There are two implications of strong growth in the rest of the world. First, U.S. export growth should remain solid. Although the external sector probably will not contribute as much to overall U.S. real GDP growth as it did in the fourth quarter anytime soon, net exports probably won’t exert a significant drag on the U.S. economy either. The second implication is that central banks in major foreign economies will likely tighten further. Indeed, we look for both the ECB and the Bank of England to hike rates again by 25 basis points this quarter. The Bank of Japan will likely tighten further, albeit at a very gradual pace.

With the Fed on hold, interest rate differentials between the United States and the rest of the world should narrow further, which will likely erode the relative attractiveness of U.S. fixed income securities. Although the U.S. current account deficit should narrow somewhat in the quarters ahead, it will still require very large net capital inflows simply to keep the dollar steady. That seems like a tall order in an environment of narrowing interest rate differentials.

Hence, we look for the greenback to trend lower versus most major currencies in the quarters ahead.

Economic Workout Continues

Just as a company working through past excesses, the economy continues to work through its overspending on housing as well as secular shift in the auto industry and demographic changes.

During the first half of 2007, housing should remain a significant drag on the economy. Real GDP is expected to grow two percent during the first half of the year and a bit stronger in the second half, as the negative growth implications of housing diminish. Unfortunately, we do not expect core inflation to moderate, as rising labor compensation costs and declining productivity, both typical of the mid-cycle economy, conspire to raise prices.

Domestic Demand

Consumer spending growth should benefit from continued real income gains and the improvement in consumer psychology due to a tight labor market.

Employment and income growth should remain relatively solid. After expanding at 3.3 percent last year we expect personal consumption expenditures (PCE) to rise more than three percent this year. Spending for motor vehicles and other big-ticket items is expected to moderate over the course of 2007, which should help push the saving rate up from its record lows hit this past year.

Business fixed investment has weakened sharply especially equipment and software spending. Two fundamentals--slower final sales growth and reduced corporate profit growth--do suggest slower investment. On the plus side, capacity utilization and capital costs remain favorable. In recent quarters, the weakness in business equipment spending does appear to have declined more than fundamentals suggest. Our outlook for steady gains in capital spending for 2007 would require a pick-up in orders and shipments of non-defense capital goods in the months ahead.

Government spending will also provide a slight boost to overall growth in the coming year. State and local government budgets have improved dramatically over the past year. Many have held back on major infrastructure projects due to sharply higher construction costs. With costs having moderated in recent months, many projects will now likely move forward.

Net Exports: A Plus for Growth and an Opportunity

Overlooked in all the pessimism about housing is the strength of export demand and the likely positive add to growth from net exports. The globalization of capital markets and product markets suggests new opportunities for business leaders ahead.

Interest Rates and Credit Risks

Slower economic and profit growth, along with the slide in the housing market, indicate a higher risk profile for creditors. Credit spreads have widened and delinquencies on subprime mortgages have surged in recent months. Given the above target pace of inflation, we do not expect any Fed easing this year. This leaves us with a flat-toinverted yield curve all year. So far, there has been little overt tightening in lending standards by private banks, yet some tightening is clearly coming. Tighter lending standards will shrink the availability of mortgage and business lending credit, which will moderate any gains in housing and business investment this year. We remain cautious on the credit front this year with the bias that credit issues should limit the pace of the recovery.

Published on  Thu, Apr 12 2007, 08:55 GMT

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Out Of The Danger Zone

Thu, Feb 8 2007, 09:27 GMT
by Wachovia Corp. Economics Group

Wells Fargo Investments, LLC


The U.S. economy is once again proving its resilience, largely shrugging off the dampening effects of the weakening housing market and cutbacks in the domestic motor vehicle industry. Real GDP finished 2006 on a strong note, with overall growth expanding at a 3.5 percent annualized rate. Some of this momentum will spill over into 2007.

We have raised our estimate for GDP growth this year to 2.6 percent, based largely on the recent strength in consumer spending and what appears to be the beginning of a turnaround in the nation’s trade deficit. Residential construction and motor vehicle assemblies will continue to be a drag on overall growth and business fixed investment will likely get off to a slow start this year.

The major downside risk to the economy continues to be the housing sector. We expect the bulk of the decline in residential construction to be behind us by the middle of this year. That may prove to be too optimistic, however. In addition, inventories could pull-back more than we currently expect, giving us lower GDP figures in the early part of the year.

With economic growth out of the danger zone, the Federal Reserve will likely hold interest rates steady this year. Monetary policy is currently slightly restrictive and will become even more so if GDP growth rises just 2.6 percent this year. A modest tightening, however, is long overdue and needed in order to sop up some of the excess liquidity created over the past few years.

Over the past month or so, Japanese economic data generally have been weaker than expected. Consequently, Japanese interest rates have edged lower, reflecting scaled-back expectations of further tightening by the Bank of Japan (BoJ), which has bucked the trend toward higher long-term rates in most other major economies. Widening interest rate differentials have weighed on the Japanese yen, which has dropped to a four–year low versus the dollar.

Our forecast continues to call for yen strength going forward, although we have reduced the amount of appreciation we project due to scaled-back expectations of further BoJ tightening. Should we make alterations to our forecasts of other major currencies? In our view, no. Economic data from most other major economies generally have been rather strong, and many major central banks likely will lift rates further.

Does the recent depreciation of the yen have any implication for the currencies of other Asian countries? We don’t think so. Although Japan is an important trading partner of most Asian countries, the United States and China are even more important. Thus, most Asian central banks do not target the values of their respective currencies versus the yen. We also think that the yen’s woes will have little effect on the Chinese renminbi. Chinese officials seem to be genuinely committed to opening up China’s financial markets and further renminbi appreciation, albeit at a gradual pace, and we look for the renminbi to strengthen more than 5 percent both this year and next year.

Out Of The Danger Zone

Economic conditions have firmed considerably over the past few weeks and inflation also appears to be far less threatening. Real GDP growth now looks set to expand between a 2.5 percent and 3.0 percent pace this year, with growth more likely to be near the lower end of that range. Core inflation also appears set to moderate, with solid gains in productivity offsetting a good part of the recent run-up in compensation costs.

Consumer spending is as resilient as ever. After expanding at a 4.4 percent annual rate during the fourth quarter, personal consumption expenditures (PCE) are set to rise at a 3.3 percent pace during the current quarter and should rise close to 3 percent this year. Most of this strength is front loaded, however. Spending ended the fourth quarter on a strong note, and PCE began this year up at a 1.6 percent annual rate from its fourth quarter average. Spending for motor vehicles and other big-ticket items is expected to moderate over the course of 2007, which should help push the saving rate up from its record lows hit this past year.

Employment and income growth should remain relatively solid. The annual revisions to the employment data were the largest in more than a decade and significantly raised the run rate for nonfarm employment The U.S. economy added an average of 187,000 jobs in 2006 and we expect that pace to slow to around 140,000 jobs a month in 2007. The moderation in job growth will likely lead to a slight up tick in the unemployment rate but, with wage increases accelerating, should have less impact on income.

Government spending will also provide a slight boost to overall growth in the coming year. State and local government budgets have improved dramatically over the past year. Many have held back on major infrastructure projects due to sharply higher construction costs. With costs having moderated in recent months, many projects will now likely move forward.

Business fixed investment remains an enigma. Corporate profits have been robust. Balance sheets are in pristine shape. And capacity utilization has risen nearly a percentage point above its long run average. All the necessary preconditions for a rebound in capital spending are in place, yet orders and shipments of non-defense capital goods remain disappointing.

Business fixed investment will likely get off to an unusually slow start this year but should strengthen over the course of the year. The major domestic automobile manufacturers have reduced shipments to rental car companies. In addition, orders and shipments for heavy trucks have plummeted in the current quarter, reflecting a new EPA mandate on diesel engines that likely resulted in orders being pulled forward into 2006. Investment in IT equipment also appears less robust than would be expected for this stage of the business cycle but is showing some tentative signs of strengthening.

The economy is not totally out the woods. The return of winter weather in the Midwest and along the East Coast will reverse some of the rebound we have seen in the housing sector recently. Cold temperatures have also sent energy prices back up. In addition, it is far from certain whether the housing market has bottomed out. We expect sales and new construction to decline in coming months, as there will likely be less of a pick up this spring than usual. The bulk of the drag from declining residential construction should be behind us by this summer.

There is also a risk of a more dramatic slide in the housing market. Delinquencies on sub-prime mortgages have surged in recent months, even though the unemployment rate remains extremely low. So far, there has been little overt tightening in lending standards, yet some tightening is clearly coming. Tighter lending standards will shrink the pool of potential homebuyers, which could trigger another downturn in sales and new construction.

Published on  Thu, Feb 8 2007, 09:27 GMT

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Year Ahead

Thu, Jan 11 2007, 10:53 GMT
by Wachovia Corp. Economics Group

Wells Fargo Investments, LLC


Unseasonably warm weather appears to have contributed to a slight pick up in overall economic activity during the later part of 2006. Data on home sales, consumer spending and factory output all perked up toward the end of the year, while energy prices weakened and the trade deficit shrank. Some of this strength, however, should prove illusory.

Housing and motor vehicle production are still major drags on output, with residential construction expected to slice another percentage point off fourth quarter growth and declines in motor vehicle output slicing off another percentage point. When balanced against stronger consumer spending, however, real GDP growth should still rise at around a 2.5 percent pace during the fourth quarter.

Year Ahead

We continue to look for real GDP growth to slow to around a 2 percent pace in 2007 and look for a string of seven consecutive quarters of GDP growth below 3 percent. Most of this slowing reflects the unraveling of the housing boom, which we believe still has a way to go. Consumer spending will also pack less punch but will post modest gains. In addition, exports and business fixed investment will likely offset some of the drag from the housing slump. Whether or not our near-perfect landing scenario is enough of a moderation to prompt the Federal Reserve to cut interest rates in 2007 has become an open question. The expansion looks far less precarious than it did even a few weeks ago. Provided economic conditions do not take a decided turn for the worse, a Fed ease will likely require a substantial lessoning of inflationary concerns.

Global GDP growth likely exceeded its long-run average for the third consecutive year in 2006. The Eurozone grew at its strongest pace since 2000, and monthly indicators suggest that economic activity remained solid at the end of last year. Growth should slow somewhat this year due largely to the effects of previous monetary tightening by the European Central Bank. The Eurozone is the U.K.’s most important trade partner, and slower growth in the former should constrain growth in the latter. Both the ECB and the Bank of England likely will tighten policy a bit more this year to insure that CPI inflation, which has been higher than both central banks prefer, returns to more acceptable rates.

Growth in Japan and Canada slowed over the course of 2006, but we judge that the expansions in each country remain intact. Deflation in Japan appears to have ended last year, which prompted the Bank of Japan to hike its policy rate once. We look for the BoJ to tighten further this year, albeit at a very gradual pace. In contrast, the Bank of Canada, which has lifted rates by 225 basis points over the past two years, is more likely to ease policy, to ensure that growth does not slump too much, than it is to tighten further.

The forces of globalization have helped to stimulate economic growth in many developing countries over the past few years. Real GDP growth rates in China and India have been especially robust. Although the Chinese and Indian economies should slow somewhat this year, the pace of economic activity in both countries should remain rather strong. In sum, global GDP growth should return to its long-run trend in the year ahead.

Published on  Thu, Jan 11 2007, 10:53 GMT

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Monthly Economic Outlook

Mon, Sep 11 2006, 16:00 GMT
by Wachovia Corp. Economics Group

Wells Fargo Investments, LLC


Theme and Variations: Classical Economics

Two themes continue to frame our outlook. Growth is moderating toward a slightly below trend pace. Second, inflationary pressures remain in place. The net result is that there is no recession in the year ahead. We also hold to an expectation of no change in Fed policy for the rest of the year.

Published on  Mon, Sep 11 2006, 16:00 GMT

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Monthly Economic Outlook

Tue, Jul 18 2006, 12:02 GMT
by Wachovia Corp. Economics Group

Wells Fargo Investments, LLC


There is little doubt that economic growth is slowing.

Published on  Tue, Jul 18 2006, 12:02 GMT


Archive

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Recently, the stock market has experienced high levels of volatility. If you are thinking about participating in fast moving markets, please take the time to read the information below. Wells Fargo Investments, LLC will not be restricting trading on fast moving securities, but you should understand that there can be significant additional risks to trading in a fast market. We've tried to outline the issues so you can better understand the potential risks. If you're unsure about the risks of a fast market and how they may affect a particular trade you've considering, you may want to place your trade through a phone agent at 1-800-TRADERS. The agent can explain the difference between market and limit orders and answer any questions you may have about trading in volatile markets. Higher Margin Maintenance Requirements on Volatile Issues The wide swings in intra-day trading have also necessitated higher margin maintenance requirements for certain stocks, specifically Internet, e-commerce and high-tech issues. Due to their high volatility, some of these stocks will have an initial and a maintenance requirement of up to 70%. Stocks are added to this list daily based on market conditions. Please call 1-800-TRADERS to check whether a particular stock has a higher margin maintenance requirement. Please note: this higher margin requirement applies to both new purchases and current holdings. A change in the margin requirement for a current holding may result in a margin maintenance call on your account. Fast Markets A fast market is characterized by heavy trading and highly volatile prices. These markets are often the result of an imbalance of trade orders, for example: all "buys" and no "sells." Many kinds of events can trigger a fast market, for example a highly anticipated Initial Public Offering (IPO), an important company news announcement or an analyst recommendation. Remember, fast market conditions can affect your trades regardless of whether they are placed with an agent, over the internet or on a touch tone telephone system. In Fast Markets service response and account access times may vary due to market conditions, systems performance, and other factors. Potential Risks in a Fast Market "Real-time" Price Quotes May Not be Accurate Prices and trades move so quickly in a fast market that there can be significant price differences between the quotes you receive one moment and the next. Even "real-time quotes" can be far behind what is currently happening in the market. The size of a quote, meaning the number of shares available at a particular price, may change just as quickly. A real-time quote for a fast moving stock may be more indicative of what has already occurred in the market rather than the price you will receive. Your Execution Price and Orders Ahead In a fast market, orders are submitted to market makers and specialists at such a rapid pace, that a backlog builds up which can create significant delays. Market makers may execute orders manually or reduce size guarantees during periods of volatility. When you place a market order, your order is executed on a first-come first-serve basis. This means if there are orders ahead of yours, those orders will be executed first. The execution of orders ahead of yours can significantly affect your execution price. Your submitted market order cannot be changed or cancelled once the stock begins trading. Initial Public Offerings may be Volatile IPOs for some internet, e-commerce and high tech issues may be particularly volatile as they begin to trade in the secondary market. Customers should be aware that market orders for these new public companies are executed at the current market price, not the initial offering price. Market orders are executed fully and promptly, without regard to price and in a fast market this may result in an execution significantly different from the current price quoted for that security. Using a limit order can limit your risk of receiving an unexpected execution price. Large Orders in Fast Markets Large orders are often filled in smaller blocks. An order for 10,000 shares will sometimes be executed in two blocks of 5,000 shares each. In a fast market, when you place an order for 10,000 shares and the real-time market quote indicates there are 15,000 shares at 5, you would expect your order to execute at 5. In a fast market, with a backlog of orders, a real-time quote may not reflect the state of the market at the time your order is received by the market maker or specialist. Once the order is received, it is executed at the best prices available, depending on how many shares are offered at each price. Volatile markets may cause the market maker to reduce the size of guarantees. This could result in your large order being filled in unexpected smaller blocks and at significantly different prices. For example: an order for 10,000 shares could be filled as 2,500 shares at 5 and 7,500 shares at 10, even though you received a real-time quote indicating that 15,000 shares were available at 5. In this example, the market moved significantly from the time the "real-time" market quote was received and when the order was submitted. Online Trading and Duplicate Orders Because fast markets can cause significant delays in the execution of a trade, you may be tempted to cancel and resubmit your order. Please consider these delays before canceling or changing your market order, and then resubmitting it. There is a chance that your order may have already been executed, but due to delays at the exchange, not yet reported. When you cancel or change and then resubmit a market order in a fast market, you run the risk of having duplicate orders executed. Limit Orders Can Limit Risk A limit order establishes a "buy price" at the maximum you're willing to pay, or a "sell price" at the lowest you are willing to receive. Placing limit orders instead of market orders can reduce your risk of receiving an unexpected execution price. A limit order does not guarantee your order will be executed -" however, it does guarantee you will not pay a higher price than you expected. Telephone and Online Access During Volatile Markets During times of high market volatility, customers may experience delays with the Wells Fargo Online Brokerage web site or longer wait times when calling 1-800-TRADERS. It is possible that losses may be suffered due to difficulty in accessing accounts due to high internet traffic or extended wait times to speak to a telephone agent. Freeriding is Prohibited Freeriding is when you buy a security low and sell it high, during the same trading day, but use the proceeds of its sale to pay for the original purchase of the security. There is no prohibition against day trading, however you must avoid freeriding. To avoid freeriding, the funds for the original purchase of the security must come from a source other than the sale of the security. Freeriding violates Regulation T of the Federal Reserve Board concerning the extension of credit by the broker-dealer (Wells Fargo Investments, LLC) to its customers. The penalty requires that the customer's account be frozen for 90 days. Stop and Stop Limit Orders A stop is an order that becomes a market order once the security has traded through the stop price chosen. You are guaranteed to get an execution. For example, you place an order to buy at a stop of $50 which is above the current price of $45. If the price of the stock moves to or above the $50 stop price, the order becomes a market order and will execute at the current market price. Your trade will be executed above, below or at the $50 stop price. In a fast market, the execution price could be drastically different than the stop price. A "sell stop" is very similar. You own a stock with a current market price of $70 a share. You place a sell stop at $67. If the stock drops to $67 or less, the trade becomes a market order and your trade will be executed above, below or at the $67 stop price. In a fast market, the execution price could be drastically different than the stop price. A stop limit has two major differences from a stop order. With a stop limit, you are not guaranteed to get an execution. If you do get an execution on your trade, you are guaranteed to get your limit price or better. For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better. Glossary All or None (AON) A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed. Day Order A buy or sell order that automatically expires if it is not executed during that trading session. Fill or Kill An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled. Good Til Canceled (GTC) An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order). Immediate or Cancel An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. Although this article may provide information relating to approaches to investing or types of securities and investments you might buy or sell, Wells Fargo and its affiliates are not providing investment recommendations, advice, or endorsements. Data have been obtained from what are considered to be reliable sources; however, their accuracy, completeness, or reliability cannot be guaranteed. Wells Fargo makes no warranties and bears no liability for your use of this information. The information made available to you is not intended, and should not be construed as legal, tax, or investment advice, or a legal opinion.


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