News & Analysis » US

What to Watch for in 2010

Contributed by Raymond James

By Scott J. Brown

The economy appeared to end 2009 about as expected. A few analysts were anticipating a sharper rebound last year and some felt that the financial difficulties would be a bigger drag. However, the consensus view was that the recovery would be gradual, with continued job losses for some time. The good news is that the pace of job destruction slowed dramatically in late 2009 – although new hiring does not appear to have picked up much. Labor market improvement will be a key factor in the 2010 economic outlook. However, there are plenty of other questions regarding bank lending, financial regulatory reform, taxes, and Fed policy. The outlook is likely to become more optimistic, but still a bit guarded in the near term.

The consumer fared poorly in 2009. Private-sector wage income fell 4.9% y/y in the first 11 months of the year, although disposable income rose 1.3% – thanks to the economy’s automatic stabilizers (tax payments fall and transfer payments, such as unemployment insurance, rise during recessions). Weakness in wage income was largely the result of job losses. A sustainable economic recovery will eventually require job gains.

Job losses were extremely high at the start of 2009, but the pace of layoffs slowed over the course of the year. In December, initial claims for unemployment insurance dropped toward a level consistent with relatively minor net job losses. Anecdotal evidence suggests that new hiring has not begun to pick up much, but that should change. Firms typically increase their hiring in the spring (unadjusted payrolls usually rise from February to June). This year will see some boost from hiring for the 2010 census (The Census Bureau will have more than 700,000 additional workers at the peak in April). These are temporary jobs and many of them are part-time, but this could serve as a sort of pump-priming, especially if it helps to improve business sentiment and consumer confidence.

Banks tightened credit considerably for consumers and small businesses during the financial crisis. However, bank lending should loosen up over time, helping to reinforce the economic recovery. Fed policy should remain supportive for bank lending. Small businesses accounted for a third of net job growth in the two previous expansions, so improved credit flow is crucial.

Longer-term, financial regulatory reforms will be important in ensuring that the causes of the financial crisis are not repeated. A large part of the problem was that there was no systemic regulator, someone in charge of overseeing the whole financial system. Currently, there is a turf battle being played out in Congress. The Federal Reserve would seem to have a good case for being the systemic regulator. The information gleaned from more comprehensive monitoring of the financial system would also help the Fed in setting monetary policy. However, there is significant opposition to the Fed being the systemic regulator. Turf battles could lead to a less desirable outcome.

The Bush tax cuts are set to sunset at the end of this year. This creates a political dilemma for both Democrats and Republicans. The GOP has made a lot of noise about the budget deficit, but tax increases are not likely to be advocated. As the mid-term election approaches, the Democrats may fear the loss of Congressional seats if taxes are set to be raised (which they are if nothing happens). A tax increase in a fragile economic recovery is the last thing you would want to do. Additionally, all tax cuts are not equal – it’s unclear what priority will be given to capital gains taxes vs. marginal tax rates and so on. Given the animosity between the two political parties, there’s a good chance that a compromise may not be reached.

Federal Reserve policy is perhaps the biggest question mark for 2010. In the December 16 policy statement, the Federal Open Market Committee repeated that conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period (conditional on elevated unemployment, low core inflation, and well-anchored inflation expectations). Most likely, the Fed will remain on hold well into the second half of the year and probably into 2011. Remember that Chairman Bernanke is an expert on the Great Depression and is well aware of the danger of removing stimulus to soon. With the fiscal stimulus package ramping down in the second half of this year and taxes likely to rise in 2011, Bernanke should be unwilling to saddle the recovery with another burden – but that depends on whether inflation is expected to remain low. Most likely, it will.

Real GDP growth in 4Q09 is likely to have been well above a 4% annual rate (possibly 5% or more), but that’s largely an inventory story. Growth should average about 3.0% to 3.5% over the next four quarters – a good recovery, but somewhat lackluster given the depth of the recession.