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Economic Outlook in 2009
2009년 미경제 전망
It is clear that 2008 was not a very good year
and it is official that the current U.S. recession started already
in December 2007. So how far are we into this recession that has
already lasted longer than the previous two (1990 and 2001
recessions lasted 8 months each)? We believe the U.S. economy is
only half way through a recession that will be the longest and most
severe in the post war period. U.S. GDP will continue to contract
throughout 2009 for a cumulative output loss of 5% and a recession
that will last close to two years.
One last look at 2008 will reveal a very weak fourth quarter with
GDP growth contracting -6%, in the wake of a sharp fall in personal
consumption and private domestic investments. We see the real GDP
growth contraction playing out through the year as follows: Q1 2009
-5%; Q2 2009 -4%; Q3 2009. -2.5%; Q4 2009 -1%, adding up to a yearly
real GDP growth of -3.4% for the U.S. in 2009.
Personal
Consumption
The resilient U.S. consumer started to give up in the third quarter
of 2008, when for the first time in almost two decades, personal
consumption contracted. With personal consumption making up over
two-thirds of aggregate demand, the outlook for the U.S. consumer is
at the center of the dynamics that will play out in the real economy
in 2009.
In our view, personal consumption will continue to contract
throughout 2009 quite sharply as a result of negative wealth effects
from housing and equity market losses, the disappearance of home
equity withdrawal from the second half of 2008, mounting job losses,
tighter credit conditions and high debt servicing ratios (the debt
to income ratio went from 70% in the 90s, to 100% in 2000 to 140%
now). This retrenchment of the U.S. consumer will result in a
painful rebalancing in the economy that will eventually restore the
saving rate of a decade ago.
The wealth losses for households related to the fall in home prices
are roughly $4 trillion so far, and are clearly bound to increase
further as home prices continue to fall –eventually reaching the
$6-8 trillion range (compatible with a 30-40% fall in home prices
peak to trough). With a negative wealth effect of 6 cents on the
dollar, the reduction in personal consumption could amount to a
whopping $500bn. And negative wealth effect from fall in equity
prices – on the wake of a bleak 2009 for corporate profits – will
also contribute to the contraction in personal consumption by an
estimated $100bn (compatible with a 25% contraction in the stock
markets).
This adjustment is consistent with a rebalancing of the economy that
will over time bring the saving rate to a positive level of roughly
5-6% where it was a decade ago, for this to happen consumption has
to contract by an amount close to $800bn.
Housing
Sector
The 4th year of housing recession is well on course.
Total housing starts have plunged from the 2.3 million seasonally
adjusted annual rate (SAAR) peak of January 2006 all the way to the
625 thousand SAAR of November 2008 (the last data point available),
an all time low for the time series that started in January 1959.
Single-family starts built for sale are down 75% from their Q4 2005
peak (seasonally adjusted data are not available, we performed our
own seasonal adjustment).
On the demand side, new single-family home sales are down 65% from
their July 2005 peak. Both demand and supply of homes are therefore
still falling very sharply which does not bode well for
inventories. Inventories are the mortal enemy of prices for any
goods-producing sector, including housing.
Starts need to fall substantially below sales so that the excess
supply in the housing market is reabsorbed. Inventories persist at
record highs and the gap between one-family starts (for sale) and
one-family sales (-92K annual rate in Q3 2008 according to our
estimates) is at levels that cannot promote a fast work–off of
inventories. To put these numbers in perspective, compare this with
a measure of vacant homes for-sale-only. Vacant homes for-sale-only
were at 2.2 million in Q3 2008, an all time high. In the decade
between 1985 and 1995 it oscillated around 1 million units on
average and 1.3 million units between 2001 and 2005. This implies
that we have to deal with an excess supply that ranges between 0.9
and 1.2 million units, of which roughly 85% are single-family
structures.
The sharp and unprecedented fall of starts might not have reached a
bottom yet. In this economy-wide recession, weakness on the demand
side is bound to persist and we believe that supply will have to
fall further, given also the great wave of foreclosures that is
adding to the excess of supply in the market. We see starts falling
another 20% from current levels.
We believe that home prices will not bottom out until the middle of
2010. Our target is a 38% peak to trough (so far prices have fallen
25% from the peak) but given the worsening conditions on the real
side of the economy, we see a meaningful chance for over-correction
that would bring prices down 44% from the peak reached in the first
half of 2006 (Case-Shiller is the reference index for these
predictions.)
Labor Markets
With continued credit crunch and significant cut down in consumer
and business spending, the monthly job losses will continue in the
400-500k and 300-400k range during the first two quarters of 2009
respectively, bringing the unemployment rate to 8% by mid-2009. The
severe contraction in private demand until early 2010 will keep
lay-offs high and the unemployment rate elevated over 8%.
Economy wide job cuts are expected, with big corporations and small
enterprises, residential and commercial construction, financial
services and manufacturing continuing to shed jobs at a strong pace.
Moreover with structural shifts in the economy since the last
recession, job losses this time will be more severe in the service
sector, including retail, business and professional services and
leisure and hospitality. Unless the fiscal stimulus addresses the
deficit problem for state and local government, job losses at the
government level will also gain pace. In turn, income and job
losses will further push up default and delinquency rates on
mortgages, consumer loans and credit cards. Moreover, the loss of
high paying corporate and financial sector jobs will be a big
negative for tax revenues over the next two years.
Lay-offs are bound to continue thereafter as cost-cutting gains pace
with the beginning of the (sluggish) recovery period in early 2010.
Even as consumer demand might show some signs of recovery, firms,
like in the past, will begin by hiring only part-time and temporary
workers initially. The unemployment rate might peak at close to 9%
in Q1 2010, almost two years after the recession began. However,
the hiring freeze across industries that began in late 2007 will
continue at least until 2010 causing discouraged workers to leave
the work force and containing the extent of the spike in the
unemployment rate. Further, the decline in labor utilization will
add to the deflationary pressure in the economy. An aging labor
force, lower capital spending and potential growth over the next few
years might also result in lower productivity growth and an increase
in the natural rate of unemployment (NAIRU).
Capital Expenditure
Firms have been drawing down inventories beginning in Q4 2008. As
the slump in domestic and foreign demand and difficulty in accessing
short-term credit persist over the next four quarters, business
investment is bound to contract in double-digits throughout 2009.
Industrial production, spending on equipment and durable goods will
also remain in red through 2009. Moreover with a sluggish recovery
in private demand even during 2010, firms will start building
inventories and contemplate capex plans only at a slower pace.
Trade
Exports contraction that began in late 2008 will gain pace in 2009
as more and more emerging economies slip into slowdown following the
G-7 countries. On the other hand, easing oil prices and secular
downward trend in consumer spending and business investment will
help imports to shrink. In fact, this might cause the trade deficit
to contract in 1H 2009 since the contraction in imports might well
exceed the decline in exports, thus containing any negative
contribution of trade to GDP growth.
Dollar Outlook
The fate of the U.S. dollar in 2009 rests on the
global growth outlook. After profit-taking on long USD positions
ends and trading volumes pick up as investors return from their
holidays, the dollar may temporarily recover its relative safe haven
status in H1 2009. Since markets have yet to fully appreciate the
impact of the commodity slump and financial crisis on the rest of
the world, risk appetite may collapse again on signs of a deeper- or
longer-than-expected recession outside the U.S.. Further
de-leveraging of USD-denominated liabilities could provide an
additional boost to the dollar as a funding currency. The bond
yield outlook could be a further source of strength: while the Fed
is already at ZIRP, other central banks will cut rates further to
stimulate growth, putting downward pressure on currencies like the
Euro. Alternating with these upside risks to the dollar may be
downside risks from 1) a supply crunch in commodities that lifts
commodity prices and producers' economies, 2) inability of the
market to absorb increased Treasury supply at low yields.
Downside risks to the dollar seem more likely to
outweigh upside risks in the latter half of 2009 and in 2010. Yet
at the same time, similar downside risks exist for other currencies
– growing fiscal deficits will weaken a range of currencies. With
emerging markets continuing to have trouble attracting capital and
Asian economies, hammered by export contractions, will be reluctant
to allow their currencies to appreciate against or with the dollar –
China allowed some depreciation of the RMB at the recent euro-dollar
peak.
Once crucial support from deleveraging wanes,
however, the dollar may be left with only foreign central bank
reserve accumulation, which has already waned on the reversal of
capital flows, to finance the large U.S. current account deficit.
Continued repatriation of assets and higher enforced domestic
savings rates will at least reduce pressure on the dollar in the
short-term.
Inflation/Deflation
Annual U.S. inflation, as measured by official producer and
consumer price indices, is likely to slow in 2009 and even fall into
technical deflation despite increases in the monetary base and
fiscal measures to boost spending power. Slumping commodity prices
may drag down the average annual headline CPI inflation rate to
around -2% - a technical deflation which may morph into genuine
deflation if falling prices generate expectations that they will
continue to fall. Meanwhile, the growing slack in product and labor
markets will keep core consumer inflation subdued at an average
year-over-year rate of 1-2%. Steep discounts to get rid of unsold
retail inventory, rising job losses and lower wage growth will
reinforce the trend of stagnant or falling prices. Loose labor
markets and weak demand for commodities and goods/services will keep
producer prices at bay. Risks to the outlook include 1) a commodity
supply crunch or geopolitical shock that leads to a sustained rise
in commodity prices and 2) an earlier than expected global economic
recovery.
Credit Losses Still Ahead
Back in February 2008, Nouriel Roubini warned that that the credit
losses of this financial crisis would amount to at least $1 trillion
and most likely closer to $2 trillion. As of mid-November 2008, the
threshold of $1 trillion in global financial writedowns was finally
reached. Given that national house prices expected to drop another
20%, we expect credit losses of $1.6 trillion.
An in-depth analysis of current and expected loan losses per asset
class and separately of mark-to-market writedowns per securities
class based on current prices indeed confirms RGE’s initial loss
range estimates (outstanding loan and securities amounts as in IMF
GFSR, Table 1.1) For our calculations we assume a further 20% fall
in house prices, and an unemployment rate of 9%. With respect to
credit losses on unsecuritized loans, recent research by the Fed
Board using comparable assumptions (but assuming high oil prices)
concludes that over half of 2006-2007 subprime mortgage originations
are going to default (i.e. $150bn out of $300bn). The loss
trajectories for Alt-A loans are similar resulting in a 25% default
rate ($144bn out of $600bn). Even prime mortgage delinquencies
display a very high correlation with subprime loan delinquencies,
implying an approximate 7% default rate when the potential for
‘jingle mail’ is taken into account ($105bn out of $3,800bn).
The cycle has also turned in the commercial real estate (CRE) arena
with the traditional lag of around 2 years. Current serious
delinquency plus default rates of 5.9% of CRE loans (net recovery,
via Fed data) are projected to increase to up to 17% by Fitch
assuming a 25% fall in prices ($142bn out of $2.4 trillion.) In the
consumer loan area, we estimate credit card charge-off rate could
increase to 13% in the worst case scenario. Adding a typical 5%
delinquency rate during recessions, the total loan losses on
unsecuritized consumer loans are projected to increase to $252bn out
of $1.4 trillion (see The U.S. Credit Card Industry in 2009, by
RGE’s Mathias Kruettli.)
The IMF warned that commercial and industrial loans (C&I) charge-off
and delinquency rates are likely to climb to historical peaks and
potentially beyond in this cycle. Compared to past C&I loan loss
rates, we project charge-off and serious delinquencies to reach 10%
or $370bn out of $3.7 trillion of unsecuritized C&I loans. With
regard to leveraged loans, the latest research by Boston Consulting/IESE
Business School based on the 100 largest PE firms engaged in LBOs
calculates an expected book loss from default of about 30%. This
translates into $51bn out of $170bn unsecuritized leverage loans.
Based on these calculations, RGE expects total loan losses to reach
about $1.6 trillion out of $12.4 trillion of unsecuritized loans
alone, implying an aggregate default rate of over 13%. The IMF
assumes that the U.S. banking system carries about 60-70% of
unsecuritized loan losses (and about 30% of mark-to-market losses on
securitizations). Even assuming that future loan losses are fully
discounted at current market prices, deploying the remaining TARP
funds towards recapitalizing the banking system would still be
warranted.
The Disconnect Between Bond and Equity
Markets
U.S. government bonds were on a tear in 2008, while equities
plummeted in a nasty bear market. Bond yields at the long end
hit all-time record lows, while the short end even dipped
into negative territory. Only TIPS suffered as deflation
risks rose. Stocks, on the other hand, had their worst year since
the Great Depressions: DJIA lost 34%, S&P 500 -38.5%. At its 2008
low on November 20, the S&P 500 was down 49% for the year and 52%
from its October 2007 peak. Stocks rallied in December though,
resulting in an apparent disagreement between the stock and bond
markets over the outlook for the U.S. economy. Bond markets seemed
to be discounting a recession in 2009 while stock markets have been
gaining since late November. This disconnect may vanish in 2009
though if the stock market rally was really just a bear market rally
due to portfolio re-balancing and thin year-end trade volumes.
However, there have been intimations that the bond market is in a
bubble about to burst in 2009. Indeed, with ultra low bond yields,
investors may be tempted to switch into higher-yielding equities -
which are now considered by many to be undervalued.
Valuation, however, is not the be-all and end-all of asset
performance. The credit freeze needs to end before equities can see
the end of the bear market. However, considering the likely
economic stagnation ahead, bonds should be a better bet than
equities for some time. We see meaningful downside risks to stock
prices as bad macro news – worse than expected – continues to
dominate in 2009. Using the S&P 500 as benchmark, earnings per
share will stay in the $50-60 range – and earnings will fall
further. If, and it is not unusual during recessions, P/E ratio
falls in the 12-14 range, we could see another 25% slide in stock
prices.
Fiscal and Monetary Policy
Fiscal Policy
A lot of hope is being placed on the expected fiscal stimulus
package of around $750 bn spread over 2009-10 including 40% of the
stimulus in tax cuts for households and firms. Around half of the
stimulus is expected to kick-in starting Q2 2009 and through 2010.
But this will fall short of the pull-back in private demand of close
to $1 trillion during this period.
Infrastructure spending, in spite of being highly effective, might
not be timely, stimulating the economy only in late-2009 and 2010
when it has well passed the severe recession phase only to
exacerbate the ballooning fiscal deficit. Nonetheless, around
$100bn of infrastructure investment might be able to kick-in during
2009. Moreover, job creation in infrastructure might be
overestimated given limitations in moving laid-off workers from
other sectors to the infrastructure projects. As such, any job
creation via government spending and tax incentives for firms will
significantly fall short of the ongoing lay-offs.
Given the drawback
of the ‘spending’ component of the stimulus, the government may be
enticed to implement
more tax cuts. While tax incentives for households like payroll and
child tax credit might be well-targeted at the group with high
propensity to spend, tax cuts in general will be less effective in
stimulating demand given a secular rise in the saving rate expected
over the next few years. Likewise, tax breaks for firms hiring new
workers or investing in new equipment will be rather ineffective
since businesses see little viability in doing so during a slump in
domestic and export demand. At the most, tax stimulus in spite of
being timely and well-targeted will cause only a temporary rebound
in the economy for a month or a quarter merely shifting the spending
decision period just like tax rebates did in 2Q 2008.
Expansion of unemployment benefits, food stamps and
other incentives will have a high bang-for-buck effect in 2009 and
will only assuage the impact of the recession. The stimulus will
also include up to $100 bn for state and local governments to meet
their severe budget shortfalls including grants, Medicaid and
unemployment insurance funds, preventing cutbacks in public
services, investment and jobs in several recession-hit states. But
again, fiscal aid for states often suffers from time lags.
Fiscal stimulus,
TARP spending, GSEs-related expenditure along with further slowdown
in corporate and individual income tax revenues will push the fiscal
deficit to around $1.3 trillion in FY2009.
Monetary Policy
The Fed has enacted a wide and unprecedented range of measures to
mitigate the credit crisis and stimulate the economy. It has
already cut its target range for the Fed funds rate down to 0-0.25%
(essentially ZIRP) but, more importantly, it has created
currency swap lines and an alphabet soup of programs to provide
liquidity to the financial system and clean out toxic financial
assets. The Fed experimented with different forms of financing
itself in order to enable a sharp expansion of its balance sheet to
accommodate these liquidity facilities. In addition to rate cuts
and quantitative easing, the Fed has directly aided failing
financial institutions. Now, the Fed is considering issuing its own
debt and/or purchasing long-dated Treasuries and Agency debt. Will
the monetary easing work? So far, the increase in money supply has
not been accompanied by an increase in the velocity of money. In
other words, credit growth remains stagnant as banks are reluctant
to lend back out the money provided by the Fed and, at the same
time, borrower demand has fallen.
RGE Monitor
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