Market News
	FOCUSES We have a new web feature--our daily and weekly focuses, which give you vital information about the markets, the economy, rates, and more. Click here to see Today's Focus Report Click here to see This Week's Focus Report
	Economic Outlook The meltdown in the economy in 2008/2009 was steep and destructive, with U.S. industrial production and export volumes collapsing by double-digit percentages. There still exist many hurdles to the kind of vigorous rebound usually seen following such a deep recession, such as credit restraint, heightened job insecurity, and small business pessimism. Additionally, the economy remains saddled with an enormous debt burden. Private credit growth has slowed sharply and, in fact, is negative for the first time since WWII. But overall indebtedness has not been dented much, and a great deal of the contraction has occurred as the result of write-offs rather than pay-downs, and has been replaced by increasing public debt. Income growth has been and remains anemic, making it difficult for consumers to service their debt, much less pay it off. However, as daunting as these impediments are, they do not argue for double-dip recession. Consumer spending remains crucial to the economic and financial outlook. The confluence of high unemployment levels, excessive debt, and tight consumer lending may keep the consumer on the defensive through 2010, but barring a major shock to confidence stemming from exogenous factors, consumer spending should eventually gain altitude on a modest trajectory as slow, grudging progress in the labor market continues. Although it has climbed from recent lows, personal savings remains below its historical average and the need to boost it following the past couple of years’ massive wealth destruction will keep spending at a lower plane than in previous recoveries. With consumers no longer able to tap freely into home equity, the savings rate will be under upward pressure for some time to come. The era of rampart debt-fueled spending has ended. Since consumer expenditures account for approximately 70 percent of economic activity, it follows that a sustained, robust recovery is probably not in the cards. With economic growth unlikely to be strong enough to absorb a significant amount of productive capacity and the unemployed, inflationary pressures should remain muted this year. This should prevent the Fed from moving too aggressively and becoming an additional impediment to the ongoing modest economic recovery. Thus, even as the Fed talks about implementing an exit strategy from accommodative emergency monetary policy conditions and has begun to normalize the discount rate, the overriding theme in Fed texts (the minutes of the January 27^th FOMC meeting and the statement announcing the discount rate hike) and speeches is that the Fed is in no hurry and policymakers do not want to make any changes that might upset the recovery until it is firmly in a self-reinforcing phase. This is evidenced by the retention of the “exceptionally low” rates on federal funds for “an extended period” and the pains the Fed took in announcing their action on the discount rate to say it did “not signal any change in the outlook for the economy or for monetary policy.” So, what is the Fed’s outlook for the economy? In his February 24^th presentation of the semi-annual Monetary Policy Report to Congress, Fed Chairman Bernanke remained cautious about the U.S. economy. He echoed many of the comments revealed in the minutes, released on February 17^th, of the January 27^th FOMC meeting, where the Committee continued to see moderate growth and subdued inflation and data received over the inter-meeting period indicated growth had strengthened, but apparently not more than anticipated by the Committee’s forecast. Available indicators were described as “mixed” and showed “substantial variation across sectors.” Chairman Bernanke, in his MPR testimony, said that a significant portion of the rebound in growth in the second half of 2009 reflected reduced inventory liquidation. As the inventory boost and support from fiscal stimulus fades, “growth likely will diminish.” It is merely being realistic to express caution about the sustainability of the recovery. The housing sector, which was at the center of the whirlpool that dragged down the economy in the first place, is starting to show distress again. The unexpected deterioration in January’s home sales data was a real wake-up call for the outlook. A sustainable rebound in housing remains a key ingredient to the overall economic recovery. Sales of new homes fell for the third consecutive month, and the inventory of unsold homes rose from 7.2 to 7.8 months. This inventory figure doesn’t include the “shadow” inventory of homes foreclosed by financial institutions not yet put on the market. Moreover, the Mortgage Bankers Association’s purchase application index declined to a 12-year low. A second sector also at the center of the whirlpool and a key element to the recovery is the banking system. In the last week of February, the Federal Deposit Insurance Corporation (FDIC) released its Quarterly Bank Profile for the fourth quarter of 2009. Details of the report suggested that the financial sector is trying to mend, but its recovery is likely to remain on a gradual path with some remaining chug holes. The number of problem banks continued to climb, rising to 702 institutions, the highest since 1992. The problem banks’ combined assets totaled $402.8 billion. Industry lending fell as banks seek to avoid risk and emerge from the financial crisis, and as loan losses continued to rise for the twelfth straight quarter. Meanwhile, the FDIC’s deposit insurance fund had a negative balance at the end of the quarter, not yet reflecting the three-year prepayment of fees requested from financial institutions. Unemployment, as a proxy measure of the output deficit at which the actual economy is running versus its potential, remains disappointing. As the Fed Chairman elaborated in his MPR testimony, “the job market remains quite weak, with the unemployment rate near 10 percent and job openings scarce.” The bottom line: short-term policy rates are headed nowhere for now, especially at a time when the economic data will appear muted-to-weak, as the nationwide inclement winter weather during January and February starts to be reflected in the economic reports. While the Fed will continue to exit from emergency credit easing and liquidity facilities, the central bank will likely keep rate policy largely unchanged for the indefinite future. The economy remains uneven and fragile, and inflation should not rear its ugly head for the next several years at least. The increased economic slack in conjunction with continued high productivity and competition for diminished consumer demand means that price pressures should remain contained. Currently, the Fed is not likely to begin to raise the fed funds rate until late 2010, but challenges to the economy including renewed weakness in housing, continued declining bank lending, and further weakening in public sector finances, not just federal but also state and local, could easily defer Fed rate action until 2011.