Recovery outlook: growth next year

Modest developments on several fronts have some experts foreseeing expansion in 2010.

By , Staff writer

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    Bernanke: The Fed chief says the central bank expects a ‘gradual’ return to growth in the second half of this year and a ‘moderate expansion’ next year.
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Finally, there is talk about a resurgence of the US economy.

The turnaround is not right around the corner. But many economists, including some policymakers, think a change from red to black ink could start to happen by year-end. If things begin clicking, next year could see a return to modest – maybe even close to normal – economic conditions.

“We’re starting to see some prerecovery activity – something you see just before the economy comes hopping back to expansion,” says Gregory Miller, chief economist at SunTrust Banks in Atlanta.

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Before congressional panels on Tuesday and Wednesday, Federal Reserve chief Ben Bernanke raised the prospect of better times ahead. He said the Fed expected a “gradual” return to growth in the second half of this year and a “moderate expansion” next year. His testimony was almost like a hint of spring for the financial markets: Investors drove the Dow Jones Industrial Average up 236.16 points Tuesday.

The markets were also encouraged that Mr. Bernanke said he was not in favor of nationalizing the banks, which on Wednesday were undergoing a Fed stress test to see how they would perform in an even more difficult economic environment.

In fact, Bernanke went out of his way to stress that no large bank will be allowed to fail.
Of course, there are some caveats. The downside risks to the economy, Bernanke says, outweigh the upside possibilities. The global nature of the economic downturn could keep US exports on the sidelines. Bernanke also worries about the negative feedback loops, where bad news becomes self-fulfilling. And the financial markets will have to show some stability.

But if financial stability returns, Bernanke says there is a “reasonable” prospect that the current recession will end in 2009 and 2010 will be a year of recovery.

Unfortunately, any recovery might not do much immediately for those who have lost their jobs. Business is often slow to rehire, preferring to add hours to its remaining workforce before hiring new workers. That is partly why Bernanke predicts the unemployment rate by the end of 2010 will still be high – 8 to 8.25 percent, close to its expected peak this year.

Accelerating job losses is one reason that Fred Dickson, chief market strategist at D.A. Davidson & Co., is less sanguine. “We’re not seeing a sign the job losses are leveling off here in the Northwest,” says Mr. Dickson, who is based in Lake Oswego, Ore. “If anything, it’s getting worse.”

Discussing economic growth may seem strange considering the current downturn. A figure for gross domestic product in the fourth quarter of last year will probably be revised lower to show the economy shrank by 5.5 percent instead of 3.8 percent, economists say. This quarter, the economy could lose another 5.5 percent.

“Right now, we are heading downhill big-time,” says Lyle Gramley, a former Federal Reserve governor.

However, Mr. Gramley is hoping the economy bottoms out by midsummer, with perhaps zero growth. By year-end, he anticipates the economy will begin to find its legs again.

Gramley sees signs the financial sector is finally starting to stabilize. The Fed has backstopped the commercial paper market, a financial instrument that helps large companies fund short-term needs. Wall Street has been successful at selling high-grade corporate bonds, which will help companies fund longer-term projects. And, he says, a new funding mechanism by the Fed could help re­energize the asset-backed commercial paper market. This could help banks make more loans to small business and consumers.

“There are some signs the financial markets have improved since the beginning of the year,” Gramley says.

One of the more positive signs that Mr. Miller of SunTrust is seeing: some slight improvement in the new-home market, which is often a leading indicator of improvement in the economy. “Production has slowed down, and builders are erecting different sorts of housing – affordable places that are 2,500 square feet in size and further outside of cities,” he says.

He also thinks the economy will get something of a boost from companies restocking depleted inventory. “There are any number of examples, like electronics firms, that need to bring on new models into inventory even if sales are not doing well,” Miller says.

Miller is also encouraged by some signs that companies are dusting off some capital spending projects. “It’s still pretty weak, but it’s getting to the point where companies have to do some replacement spending,” he says.

The economy will also start to get some energy from the fiscal stimulus package. Starting in April, wage earners will, on average, have about $65 a month less in payroll taxes taken out.

However, this element of the stimulus plan will probably have a marginal impact. “When you are giving out $15 a week, there is not as much impact as sending out a check,” says David Wyss, chief economist for Standard & Poor’s in New York.

Instead, Mr. Wyss expects the bulk of the impact to come at the end of this year or in 2010, when some of the spending on roads and bridges gets under way. “Realistically, it’s probably going to take longer than the states promised to get a shovel in the ground,” he says. “But we need it, and it does add jobs here in the US.”

Finally, Wyss expects the economy to start to improve simply because “bad things stop happening.”

For example, construction of new homes is already down 53 percent from its peak, according to the US Census Bureau. “Eventually, things stop going down,” he says. Wyss adds, “We’re starting to see some interest in people buying used cars because the prices are low and dealers need to get rid of them.”

Once the economy does recover, the Fed will have to start to mop up the enormous amount of liquidity it injected into the economy, Bernanke indicated on Tuesday. Half of that money – now close to $1 trillion – is in short-term obligations that can be withdrawn relatively quickly, he pointed out. He said the Fed is spending “a lot of time” on its “exit strategy.”

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