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Northern Trust On Economy September 2009

Northern Trust On Economy September 2009

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NORTHERN TRUST GLOBAL ECONOMIC RESEARCH

U.S. Economic and Interest Rate Outlook The Shoals of Depression Have Been Avoided, but the Economy Still Faces Strong Headwinds
September 2009 Paul L. Kasriel, Chief Economist PH: 312.444.4145 plk1@ntrs.com
© 2006 Northern Trust Corporation

northerntrust.com

We have just weathered the longest (19 months?) and deepest recession in the post-WWII era.

Real Gr oss Domestic Pr oduct
% Change - Year to Year 16 SAAR, Bil. Chn. 2005$ 16

12

12

8

8

4

4

0

0

-4 50 55 60 65 70 75 80 85 90 95 00 05 Sour ce: Bur eau of Economic Analysis /Haver Analytics

-4

2

Northern Trust Global Economic Research

In August, the ISM-Mfg. Composite Index popped above 50 for the first time since January 2008.

ISM Manufactur ing: PMI Composite Index
SA, 50+=Incr easing 56 56

52

52

48

48

44

44

40

40

36

36

32
SEP OCT NOV DEC JAN FEB MAR APR MAY JUN

32 09
JUL AUG

Sour ce: Institute for Supply Management /Haver Analytics

3

Northern Trust Global Economic Research

The behavior of the ISM-Mfg. Index suggests that the recession ended in July 2009.

ISM Manufactur ing: PMI Composite Index
SA, 50+=Incr easing 80 80

70

70

60

60

50

50

40

40

30

30

20 50 55 60 65 70 75 80 85 90 95 00 05 Sour ce: Institute for Supply Management /Haver Analytics

20

4

Northern Trust Global Economic Research

It is not that any one sector is soaring …

…rather a number of sectors have either stopped descending or are descending at a much slower rate.

Thanks to the sharp decline in home prices and the low level of mortgage rates, house purchases are now much more affordable.

Composite Housing Affor dability Index
Median Inc=Qualifying Inc=100 180 180

160

160

140

140

120

120

100

100

80

80

60 75 80 85 90 95 00 05 Sour ce: National Association of Realtor s /Haver Analytics

60

6

Northern Trust Global Economic Research

High housing affordability plus the $8K first-time-homebuyer tax credit have resulted in four consecutive monthly increases in home sales.

Home Sales: Sum of New and Existing
SAAR, Thous 9000 9000

8250

8250

7500

7500

6750

6750

6000

6000

5250

5250

4500 02 03 04 05 06 07 08 09 Sour ce: Haver Analytics

4500

7

Northern Trust Global Economic Research

The sharp decline in the inventory of new homes has led to five consecutive increases in starts of new single-family homes.

Housing Star ts: 1 Unit
SAAR, Thous. Units

New 1-Family Houses For Sale: United States
SA, Thous 2000 600

1600

525

1200

450

800

375

400

300

0 02 03 04 05 06 07 08 09 Sour ce: Census Bur eau /Haver Analytics

225

8

Northern Trust Global Economic Research

Thus, after its steep slide starting in 2006, expenditures related to residential construction appear to have bottomed.

Pr ivate Constr uction: Residential
SAAR, Mil. $ 700000 700000

600000

600000

500000

500000

400000

400000

300000

300000

200000 02 03 04 05 06 07 08 09 Sour ce: Census Bur eau /Haver Analytics

200000

9

Northern Trust Global Economic Research

The tax cuts of the fiscal stimulus program plus unemployment insurance have helped stabilize disposable personal income, which, in turn, has helped stabilize consumer spending.

Real Per sonal Consumption Expenditur es ex Motor Vehicles
SAAR, Tr il. Chn. 2005$

Real Disposable Per sonal Income
SAAR, Bil. Chn. 2005$ 9. 0 10500

8. 8

10250

10000 8. 6 9750 8. 4 9500

8. 2

9250

8. 0 05 Sour ce: Haver Analytics 06 07 08 09

9000

10

Northern Trust Global Economic Research

Car and truck sales appeared to have bottomed even before “cash-forclunkers.” There is natural replacement demand given that some of us are still driving 1995 Subarus!

Total Light Vehicle Retail Sales {Impor ted+Domestic}
SAAR, Mil. Units 22. 5 22. 5

20. 0

20. 0

17. 5

17. 5

15. 0

15. 0

12. 5

12. 5

10. 0

10. 0

7. 5 06 07 08 09 Sour ce: Autodata Cor por ation /Haver Analytics

7. 5

11

Northern Trust Global Economic Research

Some of those drill presses, computers, and 737s need replacing, too.

Manufactur er s' Shipments: Nondefense Capital Goods
SA, Mil. $ 70000 70000

67500

67500

65000

65000

62500

62500

60000

60000

57500

57500

55000 06 07 08 09 Sour ce: Census Bur eau /Haver Analytics

55000

12

Northern Trust Global Economic Research

Economic activity is improving in the developed economies …

Eur o Ar ea16: Gr oss Domestic Pr oduct
% Change - Annual Rate SA/WDA, Mil. Chn. 00. Eur os

Japan: Gr oss Domestic Pr oduct
% Change - Annual Rate 8 SAAR, Bil. Chn. 2000. Yen 8

4

4

0

0

-4

-4

-8

-8

-12

-12

-16 06 Sour ces: Eur ostat, CAO /Haver 07 08 09

-16

13

Northern Trust Global Economic Research

… as well as in China …

China: Real GDP: Year -to-Year Per cent Change
% 12 12

11

11

10

10

9

9

8

8

7

7

6 06 07 08 09 Sour ce: China National Bur eau of Statistics /Haver Analytics

6

14

Northern Trust Global Economic Research

… other developing economies.

Kor ea: Gr oss Domestic Pr oduct
% Change - Annual Rate SA, Bil. Ch. 2005. Won

Singapor e: GDP at 2000 Pr ices
SAAR, Q- Q % Change 22. 5 22. 5

15. 0

15. 0

7. 5

7. 5

0. 0

0. 0

-7. 5

-7. 5

-15. 0

-15. 0

-22. 5 06 07 08 09 Sour ces: Bank of Kor ea, Depar tment of Statistics/Haver Analytics

-22. 5

15

Northern Trust Global Economic Research

The economic recovery underway in the rest of the world is boosting U.S. exports.

Expor ts, f. a. s.
SA, Mil. Chn. 2005$ 105000 105000

100000

100000

95000

95000

90000

90000

85000

85000

80000

80000

75000 07 Sour ce: Bur eau of the Census /Haver Analytics 08 09

75000

16

Northern Trust Global Economic Research

State & local government infrastructure spending in Q2 grew at its fastest rate since 2001 due to the “Build America Bonds” program authorized by the fiscal stimulus program.

Real State & Local Govt Gr oss Investment
% Change - Annual Rate 30 SAAR, Bil. Chn. 2005$ 30

20

20

10

10

0

0

-10

-10

-20

-20

-30 01 02 03 04 05 06 07 08 09 Sour ce: Bur eau of Economic Analysis /Haver Analytics

-30

17

Northern Trust Global Economic Research

Speaking of the stimulus program, for the most part, the federal spending portion of it has yet to kick in.

Real Feder al Nondefense Gr oss Investment
% Change - Annual Rate 60 SAAR, Bil. Chn. 2005$ 60

40

40

20

20

0

0

-20

-20

-40 08 Sour ce: Bur eau of Economic Analysis /Haver Analytics 09

-40

18

Northern Trust Global Economic Research

After the largest inventory liquidation in the post-WWII era, some businesses will have to begin restocking because their shelves are bare.

Change in Business Inventor ies as % of Final Sales of Domestic Pr oduct
SAAR, Chn. 2005$ 2. 25 2. 25

1. 50

1. 50

0. 75

0. 75

0. 00

0. 00

-0. 75

-0. 75

-1. 50 50 55 60 65 70 75 80 85 90 95 00 05 Sour ce: Haver Analytics

-1. 50

19

Northern Trust Global Economic Research

Although job growth and a drop in the unemployment rate have yet to occur, both of these improving labor-market indicators tend to lag in economic recoveries.

All Employees: Total Nonfar m
% Change - Per iod to Per iod SA, Thous

Civilian Unemployment Rate: 16 yr +
SA, % 1. 6 12

1. 2

10

0. 8 8 0. 4 6 0. 0

-0. 4

4

-0. 8 65 70 75 80 85 90 95 00 05 Sour ce: Bur eau of Labor Statistics /Haver Analytics

2

20

Northern Trust Global Economic Research

But the level of first-time unemployment insurance claims is falling, which typically happens just before or at the onset of recoveries.

Initial Claims for Unemployment Insur ance, State Pr ogr ams, Wkly Avg
SA, Thous 700 700

600

600

500

500

400

400

300

300

200

200

100 70 75 80 85 90 95 00 05 Sour ce: Depar tment of Labor /Haver Analytics

100

21

Northern Trust Global Economic Research

If there is one sector that is not improving, it is commercial real estate.

Private Construction: Nonresidential

A lagging sector. High and rising unemployment will keep office vacancy rates rising. Mall vacancy rates will remain high as retailing is years away from returning to its recent boom era. Hotel vacancy rates will remain high as discretionary travel will be slow to strengthen.
40

%Change - Year to Year

SAAR, M il.$ 40

30

30

20

20

10

10

0

0

-10

-10

-20 65 70 75 80 85 Source: Census Bureau/Haver Analytics 90 95 00 05

-20

22

Northern Trust Global Economic Research

Financial market conditions are improving

After Lehman collapsed, the interbank loan market froze up. This market now is thawing as evidenced by the decline in Libor interest rates and the decline in discount-window borrowing from the Fed.

Inter est Rate Spr ead: 3-Month Libor minus Fed Discount Rate
per centage points

Reser ve Bank Cr edit: Pr imar y Cr edit to Depositor y Institutions
Avg, Mil. $ 3. 00 120000

2. 25

100000

80000 1. 50 60000 0. 75 40000

0. 00

20000

-0. 75 08 Sour ce: Haver Analytics 09

0

24

Northern Trust Global Economic Research

After Lehman failed, the bond market was pricing in a rerun of the early 1930s. Risk appetites have been whetted now that the worst case has not occurred.

Inter est Rate Spr ead: High Yield Cor por ate minus Tr easur y 10-Yr .
per centage points

Mer r ill Lynch High Yield Cor por ate Master II: Effective Yield
% 24 24

20

20

16 16 12 12 8

4

8

0 06 Sour ce: Haver Analytics 07 08 09

4

25

Northern Trust Global Economic Research

The S&P 500 was up nearly 50% from its early March low by Labor Day.

Standar d & Poor 's 500 Stock Pr ice Index
EOP, 1941-43=10 1600 1600

1400

1400

1200

1200

1000

1000

800

800

600 06 07 08 09 Sour ce: Wall Str eet Jour nal /Haver Analytics

600

26

Northern Trust Global Economic Research

The economy still faces strong headwinds

Commercial banks are experiencing extremely high loan charge-off and delinquency rates.

Loan Char ge-Off Rate: All Insur ed Commer cial Banks
SAAR,%

Loan Delinquency Rate: All Insur ed Commer cial Banks
SA,% 8 8

6

6

4

4

2

2

0 85 90 95 00 05 Sour ce: Feder al Reser ve Boar d /Haver Analytics

0

28

Northern Trust Global Economic Research

As a result, there has been an unprecedented decline in net lending by the private financial system.

Pr ivate Financial System: Cr edit Mar ket Funds Advanced
SAAR, Bil. $ 6000 6000

4000

4000

2000

2000

0

0

-2000 55 60 65 70 75 80 85 90 95 00 05 Sour ce: Haver Analytics

-2000

29

Northern Trust Global Economic Research

Financial institutions have acquired muchneeded capital through the TARP program and new equity issuance in the market. But with a wave of commercial mortgage defaults expected, some institutions could become undercapitalized again.

Until financial institutions are confident of their longer-run capital adequacy, they will be unable and/or reluctant to create new credit, which will restrain the pace of the economic recovery.

It will take households some time to recover from their “overindulgence” in the past expansion.

Total household expenditures reached record highs relative to aftertax income in the past ten years.

Sum of Consumer and Residential Investment Expenditur es / HH After -Tax Income
% 105. 0 105. 0

102. 5

102. 5

100. 0

100. 0

97. 5

97. 5

95. 0

95. 0

92. 5

92. 5

90. 0 50 55 60 65 70 75 80 85 90 95 00 05 Sour ce: Haver Analytics

90. 0

32

Northern Trust Global Economic Research

In order to fund their increased spending, households stepped up their borrowing, largely against the equity in their houses, to record levels relative to their after-tax incomes.

Households: Bor r owing as a % of After -Tax Income

15. 0

15. 0

12. 5

12. 5

10. 0

10. 0

7. 5

7. 5

5. 0

5. 0

2. 5

2. 5

0. 0 55 60 65 70 75 80 85 90 95 00 05 Sour ce: Haver Analytics

0. 0

33

Northern Trust Global Economic Research

The record increase in household debt in combination with massive declines in the market value of their assets has resulted is a sharp loss in net worth, or household wealth.

Households & Nonpr ofit Or g: Net Wor th as a % of Disposable Per sonal Income
% 640 640

600

600

560

560

520

520

480

480

440

440

400 55 60 65 70 75 80 85 90 95 00 05

400

34

Northern Trust Global Economic Research

Households are likely to rebuild their wealth through the purchases of stocks and bonds rather than the purchases of McMansions, SUVs and plasma TVs. All else the same, this would impart downward pressure on interest rates.

Households: Net Acquisition of Financial Assets
SAAR, Bil. $

Households & Nonpr ofit Or gs: Capital Expenditur es
SAAR, Bil. $ 2000 2000

1600

1600

1200

1200

800

800

400

400

0 55 60 65 70 75 80 85 90 95 00 05 Sour ce: Feder al Reser ve Boar d /Haver Analytics

0

35

Northern Trust Global Economic Research

Is the federal deficit a headwind?

Not right now. Although Treasury borrowing has soared in recent quarters, the pace of nonfederal borrowing has slowed sharply.

Feder al Gover nment: Liabilities: Cr edit Mar ket Instr uments
4-qtr MovingAver age SAAR, Bil$

Nonfeder al Sector s: Liabilities: Cr edit Mar ket Instr uments
4-qtr MovingAver age 2500 SAAR, Bil. $ 2500

2000

2000

1500

1500

1000

1000

500

500

0

0

-500 55 60 65 70 75 80 85 90 95 00 05 Sour ces: Feder al Reser ve Boar d, Haver Analytics

-500

37

Northern Trust Global Economic Research

Thus, the pace of total nonfinancial sector borrowing has slowed, which has helped keep Treasury yields at relatively low levels.

Domestic Nonfinancial Sector s: Liabs: Cr edit Mkt Instr uments
4- qtr MovingAver age SAAR, Bil. $

Long-Ter m Tr easur y Composite, Over 10 Year s
% p. a. 3000 15. 0

2500

12. 5

2000

10. 0

1500

7. 5

1000

5. 0

500

2. 5

0 55 60 65 70 75 80 85 90 95 00 05 Sour ces: Feder al Reser ve Boar d, U. S. Tr easur y /Haver Analytics

0. 0

38

Northern Trust Global Economic Research

But with federal budget deficits projected to run at rates near 4% of GDP well into the economic recovery, federal spending could “crowd out” business investment, which would lower future potential economic growth.

Feder al Sur plus/Deficit [-]: Per cent of GDP
Fiscal Year , % 8 8

4

4

0

0

-4

-4

-8

-8

-12 50 55 60 65 70 75 80 85 90 95 00 05 10 15 20 Sour ce: Office of Management and Budget /Haver Analytics

-12

39

Northern Trust Global Economic Research

Will the headwinds prevail, pushing the economy back into recession?

Not likely. Over 50 years of history suggests that the economy does not enter a recession unless the Fed pushes it into one.

Feder al Funds [effective] Rate
% p. a. 20 20

16

16

12

12

8

8

4

4

0 55 60 65 70 75 80 85 Sour ce: Feder al Reser ve Boar d /Haver Analytics 90 95 00 05

0

41

Northern Trust Global Economic Research

What about inflation? Won’t all the credit the Fed has created in recent years guarantee rapid inflation?

Fed credit has soared from $877 billion at the end of 2007 to over $2 trillion at the end of August 2009.

Reser ve Bank Cr edit Outstanding
EOP, Mil. $ 2400000 2400000

2000000

2000000

1600000

1600000

1200000

1200000

800000

800000

400000

400000

0 90 95 00 05 Sour ce: Feder al Reser ve Boar d /Haver Analytics

0

43

Northern Trust Global Economic Research

But the bulk of this Fed credit creation has ended up as currency sitting in safe deposit boxes and excess, or idle, cash sitting on the books of banks.

Reser ve Bank Cr edit Outstanding
EOP, Tr il. $

Sum of Excess Reser ves and Cur r ency in Cir culation
Tr il. $ 2. 4 2. 4

2. 0

2. 0

1. 6

1. 6

1. 2

1. 2

0. 8

0. 8

0. 4

0. 4

0. 0 90 Sour ce: Haver Analytics 95 00 05

0. 0

44

Northern Trust Global Economic Research

Although growth in the broad measure of money supply skyrocketed right after the Lehman failure, it has fallen back to Earth in recent months.

Money Stock: M2
6-month %Change-ann 15.0 SA, Bil.$ 15.0

12.5

12.5

10.0

10.0

7.5

7.5

5.0

5.0

2.5

2.5

0.0 96 97 98 99 00 01 02 03 04 05 06 07 08 09

0.0

Source: Federal Reserve Board /Haver Analytics

45

Northern Trust Global Economic Research

To summarize:

The recovery has commenced. Balance sheet repair by financial institutions and households will restrain the pace of the recovery through 2010. Because the recovery will be muted initially, the unemployment rate is likely to continue rising through the first half of 2010, perhaps peaking out at a level over 10-1/2%. The sharp increase in Fed credit is not currently inflationary, but has the potential to be if the Fed does not neutralize this credit at the appropriate time. The earliest the Fed is likely to begin “neutralizing” the credit it has created is midyear 2010 and then, only tentatively.

46

Northern Trust Global Economic Research

Selected Business Indicators

Table 1 US GDP, Inflation, and Unemployment Rate
2008 08:3a 08:4a REAL GROSS DOMESTIC PRODUCT (% change from prior quarter ) CONSUMPTION EXPENDITURES BUSINESS INVESTMENT RESIDENTIAL INVESTMENT CHANGE IN INVENTORIES ('00 dlrs, bill) GOVERNMENT NET EXPORTS ('00 dlrs, bill.) FINAL SALES NOMINAL GROSS DOMESTIC PRODUCT GDP DEFLATOR - IMPLICIT (% change) CPI (% Change, 1982-84 = 100) CIVILIAN UNEMPLOYMENT RATE (avg.) a=actual f=forecast *=annual average -2.7 -3.5 -6.1 -15.9 -29.7 4.8 -479.2 -2.9 1.4 4.1 6.2 6.1 -5.4 -3.1 -19.5 -23.2 -37.4 1.2 -470.9 -4.7 -5.4 0.0 -8.3 6.9 2009 09:1a 09:2a 09:3f -6.4 -1.0 2.5 09:4f 1.9 10:1f 1.6 2010 10:2f 10:3f 2.3 2.5 Q4 to Q4 Change 10:4f 2008a 2009f 2010f 3.2 -1.9 -1.8 -6.0 -21.0 3.1 -1.4 0.1 2.0 1.5 -0.8 0.8 -18.3 -16.7 1.9 -0.3 0.8 1.6 1.0 2.4 2.0 -0.3 3.2 1.7 2.1 4.8 2.4 2.6 Annual Change 2008a 2009f 2010f 0.4 -0.2 1.6 -22.9 -25.9* -2.7 1.9

0.6 -1.0 2.0 1.5 1.7 2.0 2.0 2.3 -39.2 -10.9 -13.2 -5.4 -3.2 -0.8 0.2 2.8 -38.2 -22.8 0.0 1.0 1.5 2.5 4.0 5.0 -113.9 -159.2 -150.9 -120.9 -115.9 -105.9 -100.9 -85.9 -2.6 6.4 2.4 1.8 1.6 1.3 2.1 1.8 -386.5 -331.8 -295.4 -293.0 -285.4 -274.3 -262.9 -253.5 -4.1 -0.1 1.7 0.9 1.4 2.0 2.3 2.7 -4.6 1.9 -2.4 8.1 -1.0 1.1 1.3 9.3 5.2 2.6 2.8 9.7 3.9 2.0 2.2 10.1 3.7 2.1 2.3 10.4 3.7 2.3 2.5 10.7 4.6 2.3 2.5 10.7 4.8 2.9 3.1 10.5

-0.7 1.7 -19.3 -4.2 -22.2 0.2 -136.2* -102.2*

3.1 1.9 2.0 -494.3* -326.7* -269.1* 0.8 -1.8 1.6 2.6 2.1 3.8 5.8* -1.1 1.6 -0.5 9.3* 4.1 2.1 2.4 10.6*

47

Northern Trust Global Economic Research

Outlook for Interest Rates

TABLE 2 Outlook for Interest Rates
Quarterly Average
SPECIFIC INTEREST RATES 08:3a 08:4a 09:1a 09:2a 09:3f 09:4f 10:1f 10:2f 10:3f

Annual Average
10:4f 2008a 2009f 2010f

Federal Funds 2-yr. Treasury Note 10-yr. Treasury Note a = actual f = forecast

1.94 2.36 3.86

0.51 1.21 3.25

0.18 0.91 2.74

0.18 1.01 3.31

0.16 1.05 3.55

0.20 1.00 3.60

0.25 1.05 3.70

0.25 1.20 3.85

0.70 1.50 4.00

1.20 1.85 4.15

1.93 2.00 3.67

0.18 0.99 3.30

0.60 1.40 3.93

48

Northern Trust Global Economic Research

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