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Volume 7, Issue 20
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Volume 8, Issue 11 |
June 1, 2010
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The Federal Reserve/Monetary Policy
· The renewed deterioration in worldwide credit markets will likely
extend the time that the Fed funds rate will be <0.25%. At its
policy meeting on June 22-23, the Fed will continue to pledge a low
Fed funds rate for an extended period-the funds rate is likely to be
<0.25% into, if not through, the first quarter of 2011. Such an
extended period of a near zero Fed funds rate has not occurred since
the Great Depression. If the deterioration in credit markets becomes
more threatening to the U.S. recovery, Bernanke will likely become
more vocal (open mouth policy) in pledging whatever Fed support is
needed to keep the economy recovering.
· Monetary policy appears stimulative based on a negligible Fed
funds rate and an unprecedented jump in Federal Reserve credit, but,
given the economic trauma of 2008/2009 and huge gyrations in
monetary/loan data, there is more uncertainty than usual about the
timing and impact of Fed actions on economic activity. Also, credit
has become less available to riskier borrowers and bank loans
continue to decline. Uncertainty about financial reform legislation
may also increase bank reluctance to lend, especially if capital
requirements are raised for large banks.
· The worldwide "flight to quality" has reduced interest rates on
U.S. Treasury securities. Last week the Treasury auctioned two-year,
five-year and seven-year bonds at yields of 0.769%, 2.13% and 2.815%
respectively. Such low interest rates reduce political pressure to
cut the Federal deficit. Tax increases scheduled to take effect in
January could be postponed if the economic recovery weakens.
The Economy/Inflation
· The economic recovery will lose a little steam as a result of the
decline in stocks, reduction in credit availability and loss of some
exports. The Index of Leading Economic Indicators declined 0.1% in
April and the plunge in stock prices, one of the index's 10
components, will be restraining the Index in May and probably June.
Nevertheless, there is less than a 20% chance that the economy will
fall back into recession (double-dip), mainly because the Fed will
provide whatever support is needed to continue the recovery.
However, the linkage between Fed actions and aggregate demand
(spending) is very loose, so there is a small risk the economy will
fall back into a modest recession.
· The 11-month-old economic recovery looks sustainable. Aggregate
dollar demand (nominal/current dollar GDP) is still expected to rise
4% to 4.5% this year and 4.5% to 5% in 2011 vs. -1.3% in 2009. Real
GDP should rise 3% to 3.5% this year and next vs. a -2.4% in 2009.
The recovery will be led by business investment in inventory and
equipment, exports, housing and Federal government purchases.
Consumer and state and local government spending will lag and
commercial construction decline sharply.
· In April, the core personal consumption price index was 1.2% above
a year ago, somewhat below the Fed's presumed comfort zone. Modest
core consumer price inflation is expected to continue through year
end. A rally in the dollar will help keep import prices low. The
Euro is down 19% vs. the dollar since the Euro's October peak.
Inflation expectations have also declined. The 10-year inflation
rate forecast implied in Treasury inflation-protected bonds (TIPs)
yields was a 2.03% at Friday's close, down sharply from 2.4% four
weeks ago.
Financial Markets
· European-initiated financial turmoil has caused investors to flee
stocks and corporate bonds and buy U.S. Treasury bonds. Gold and the
dollar have benefited from this "flight to quality." After issuing
junk bonds in record volume earlier this year, lesser quality
corporate borrowers have suddenly found the junk bond market shut.
Inter-bank lending rates, especially in Europe, have increased along
with credit jitters. Credit quality yield spreads have increased
sharply in the past four weeks, but are still within their
historical normal ranges (see Bond Market Barometer).
· Fundamentally, the Fed's monetary policy should be supportive of
stock and bond markets at least into the first quarter of 2011, i.e.
negligible short-term interest rates will keep investors seeking
higher yields in stocks, bonds and commodities.
· Sustaining the economic recovery will likely require stock market
(a leading indicator) strength. Stocks appear reasonably valued vs.
Baa corporate bonds (see Stock Market Barometer) as yields on both
the S&P 500 and Baa corporate bonds have risen. Based on forecasted
2010 earnings (subject to considerable forecast error), the
price/earnings ratio for the S&P 500 at Friday close was 13.5 versus
a 19-average over the past 22 years. Earnings have recovered
strongly and earnings are such a high percentage of the national
income (chart below) that there is a risk earnings will fall short
of expectations, especially if the recovery weakens and/or wide
currency swings and weakness in key export markets depress exports
and earnings from abroad.
· The sobering decline in stocks and high-yield corporate bonds
reduces the risk of further declines. Any further decline in stocks
or corporate bonds is not likely to be prolonged or severe.
· Mortgage rates have fallen to near record lows even though the Fed
stopped buying additional mortgage-backed securities on March 31.
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Economics Today is a monthly e-mail service provided by
Reliance Trust Company.
Main office: 1100 Abernathy Road, 500 Northpark, Suite 400, Atlanta, GA
30328 |
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Economic Outlook
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Qtr. 4 |
Q1 |
Q2 |
Q3 |
Q4 |
2008 |
2009 |
2010 |
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5.6 |
3 |
3 |
3.4 |
3.4 |
0.4 |
-2.4 |
3.3 |
|
2.5 |
1.5 |
1.4 |
1.4 |
1.5 |
3.3 |
0.2 |
1.8 |
|
1.8 |
0.6 |
1 |
1.2 |
1.2 |
2.4 |
1.5 |
1.2 |
|
3.47 |
3.72 |
3.43 |
3.7 |
4 |
3.67 |
3.26 |
3.71 |
|
0.15 |
0.13 |
0.2 |
0.2 |
0.2 |
1.98 |
0.18 |
0.18 |
|
17.16 |
19.3 |
19.4 |
20.35 |
21.5 |
49.51 |
56.86 |
80.55 |
|
n/a |
90.9 |
40.5 |
29 |
25.3 |
-40 |
14.8 |
41.7 |
|
5.66 |
5.46 |
6.05 |
6.15 |
6.35 |
28.38 |
22.41 |
24.01 |
|
-20.8 |
-8.4 |
11.2 |
15 |
12.2 |
2.3 |
-21 |
7.1 |
|
1083.3 |
1118.1 |
1145 |
1210 |
1255 |
1221.3 |
944.8 |
1182 |
|
18.8 |
38.4 |
28.4 |
21.5 |
15.8 |
-17.3 |
-22.6 |
25.1 |
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Real GDP, % annual rate |
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Inflation, PCE % an. rate |
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Core inflation (ex food&energy) |
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10 Year Treasury bond (%) |
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Fed funds rate (%) |
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S&P 500 operating earnings($s) |
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S&P 500 op. earn. Yr/Yr % chg. |
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S&P 500 dividends ($s) |
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S&P 500 div Yr/Yr % chg. |
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S&P 500 Index (average) |
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S&P 500 Index, Yr/Yr % chg. |
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Economic and Financial Data |
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Disclaimer
The material herein is based on data
from sources considered to be reliable,
but it is not guaranteed as to accuracy,
does not purport to be complete and is
subject to change without notice. It is
not to be construed as a representation
by us or as an offer or the solicitation
of an offer to sell or buy any security.
Any opinions expressed are subject to
change. From time to time, this firm,
its affiliates, and/or its individual
officers and/or members of their
families may have a position in the
subject securities which may be
consistent with or contrary to the
recommendations contained herein; and
may make purchases and/or sales of those
securities in the open market or
otherwise. This communication is for
informational purposes only. Use by
other than intended recipients is
prohibited. Sender accepts no liability
for any errors or omissions arising as a
result of transmission. Any comments or
statements made herein do not
necessarily reflect those of Reliance
Financial Corporation or its affiliates.
Securities and Insurance Products offered through Reliance Securities, LLC. Member FINRA/SIPC.
Not FDIC Insured * No Bank Guarantee * May Lose Value *
Not a Deposit * Not Insured by any Federal Government Agency.
Arnie Dill, Ph.D.
Consulting Economist
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