Monthly Economic Outlook

Economic Recovery: Unusual Shape, Unusual Style

Wed, May 13 2009, 10:24 GMT
by Wachovia Research Team - Wells Fargo Investments, LLC | View company's profile

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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.

Download Full Monthly Economic Outlook

Published On Wed, May 13 2009, 10:27 GMT

About this Report

Wells Fargo Investments, LLC

https://www.wellsfargo.com/

sam.bullard@wachovia.com

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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. 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