We continue to forecast solid economic growth in the emerging economies, coupled with slow to moderate economic growth in the U.S., to be the catalysts to a 4.5 percent gain in world GDP in 2010 and in 2011. In comparison to our forecasts six months ago, debt challenges in Greece, Portugal, and Spain will produce weaker economic activity in Europe, which will only be partially offset by stronger economic growth in Japan.
The U.S. Economy–Low and Slow
The recent surge in productivity, decline in unit labor costs, rise in corporate profits, and a partial rebound in consumer wealth, combined with the need to replenish depleted inventory positions and strong demand for finished consumer products from Asia, will continue to provide an industrial-led boost to economic activity in the U.S. However, a continued drag from the commercial construction sector, a 10+ million jobs gap, consumers still repairing their balance sheets, a run-off of stimulus from the Federal government and significant constraints from record state and local government budget shortfalls should produce an upturn in real U.S. GDP growth of 3 to 3.5 percent. Consequently, we are holding to our longer term “low and slow” domestic economic recovery scenario and have kept our assessment of the risk of a “W” or “double dip” in later 2010 or 2011 to 15 percent.
In the U.S., the gain in durable goods sales both domestically and from abroad has led to a strong rebound in new orders, shipments, and the regional and national purchasing managers’ readings. The sharp upturn in factory sector activity now includes an almost 8 percent year-over-year gain in manufacturing output (versus a 14 to 15 percent annual decline in factory output in early to mid 2009), 19.0 percent and 11.4 percent gains in business equipment and software sales in 2009:Q4 and 2010:Q1, respectively, and a solid increase in factory sector employment for the first time in four years. Although the civilian unemployment rate, currently at 9.7 percent, remains near its 10.1 percent October 2009 peak, labor market trends have shown a significant improvement the last six months. Private sector payrolls turned positive in late 2009, while household employment rebounded by almost 1.7 million people in the first five months of 2010. We look for the civilian unemployment rate to move down towards the 9 percent area over the next year and towards the 8.5 percent area by late 2011/early 2012.
Tame Inflation Keeps the Fed in a Holding Pattern
The headline U.S. consumer price inflation reading moved back into positive territory on a yearly basis in late 2009, but core consumer inflation has decelerated to less than a 1 percent annualized pace. We look for headline CPI to increase at a 1.5 to 2.0 percent pace in 2010, with core inflation likely to hover just below the 1 percent area. The excess capacity of labor will likely keep wage and salary costs under control and the pattern for wage increases in the future will be more closely tied to corporate profitability. High vacancy rates in the housing sector should continue to temper other renters’ costs (the largest CPI component at almost 25 percent) and help to keep overall inflation modest. We do not see any significant risk on the inflation front for the next 18 to 24 months, but debt burdens concern us over the longer term.
A 40+ year low for core inflation, the moderation in input costs following the crisis in Europe, and the inevitable tightening of fiscal policy, will likely provide the Fed with an opportunity to keep the current loose monetary policy in a holding pattern until late 2010. The Fed may test the water towards year end by starting to reduce the size of its balance sheet and the supply of excess reserves in the banking system. However, the bulk of this balance sheet and Fed funds rate adjustment process is now likely to be a 2011 event. We still believe that the Fed funds rate target will become just one of the tools used to set monetary policy in the upcoming years. The level of, and interest rate for, excess reserves as well as bank deposits and the discount rate will also play key roles in establishing monetary policy.
The European Challenge—Rolling Recessions
Europe’s economy could be faced with a series of rolling recessions for the next several years as the wall of debt and forced fiscal policy cutbacks will hinder economic activity, with the most extreme challenges likely to be centered in the “club-Med” countries and the European banking system. We continue to look for Greece, Spain, Portugal, and, to a lesser extent, Ireland to be the weak links in Europe that should serve to curtail overall European economic activity as well as the Euro over the near term and test the stability of the European monetary system. Economic activity in the “club-Med” countries is likely to decline between 2 and 4 percent in 2010, while Germany and France, as well as the U.K., will struggle to grow at 1 percent. For 2011, we look for lackluster 1.0 to 1.5 percent European economic growth, with the greatest risks tilted towards the down side.
Economic Improvement in Japan
Despite the challenges in Europe, Japan has shown signs of positive economic developments as witnessed by a close to 5 percent rebound in both nominal and real GDP in 2010:Q1, with broad based gains both domestically and internationally. Although this robust pace is not sustainable, the prospect for a 3 percent growth pace for Japan in 2010 and in 2011 has improved. Hence, in comparison to estimates from the IMF and OECD, we look for strong economic activity in Japan, but weaker economic activity in Europe.
The Emerging Economies--A Source of Strength
Real growth could expand by more than 6 percent in the emerging and developing economies in 2010, with China, India, and Brazil expanding at 10 percent, 9 percent, and 6 percent, respectively. The sharp reacceleration in economic activity in these regions in late 2009 and early 2010 reignited a robust expansion in bank loans and money supply, which, in turn, fueled a rebound in inflation and sparked monetary policy tightening actions. Input cost pressures, higher food costs, and signs of a bubble in the housing sector sparked restrictive actions in China, while India was forced to deal with wage inflation pressures. The recent tempering in input costs, combined with a likely slowdown in exports to Europe (China’s largest export market) should help to keep inflation pressures in check over the near term and bring an end to the tightening process in China. Likewise, the latest action by China to relax the Yuan’s peg to the U.S. dollar should also help to temper price pressures. During the year, China’s economic output should pass Japan, which will make China the world’s second largest economy.
Statements concerning Commonfund Group’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund Group fund. Such statements are also not intended as recommendations by any Commonfund Group entity or employee to the recipient of the presentation. It is Commonfund Group’s policy that investment recommendations to investors must be based on the investment objectives and risk tolerances of each individual investor. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund Group. Commonfund Group disclaims any responsibility to provide the recipient of this presentation with updated or corrected information.