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Is the Hard Part Over…Or Just Starting?
On to the Recovery, Fingers Crossed
David Watt
September 20090
US Economy About to Emerge From Period of Darkness
The Good News
The recession is ending. It might already be
over…maybe.
US GDP q/q (annualized)
6
RBC Forecast
US GDP: Poised to expand in Q3 and beyond.
Pace to be steady, unspectacular, at best.
4
2
The rebound still seems to have shaky
foundations
0
-2
Aggregate demand might do ok, but private
demand to struggle.
-4
-6
-8
2004
2005
2006
2007
2008
2009
The Square
Root
Recovery!
2010
The US consumer: No longer able to carry the
burden of growth. Headwinds to consumer are
stiffer than they have been in decades, but the
US consumer is unlikely to disappear.
But Times Have Changed.
The Bad News …. Things Still Look Pretty Dim
1
The US is Not Alone…The Global Downturn is Losing Momentum
There is More Good News
10
GDP (q/q, saar)
Likely to rise
from 2.5% to
3.0%
10
2009p
2010p
5
The global recession
is ending.
5
0
Growth is starting to
appear in many
countries.
0
-5
-5
U.K
Japan:
Germany :
Mainland Norw ay
Sw eden:
Canada:
-10
-15
-10
-15
-20
Mar-08
Jun-08
Sep-08
Dec-08
Mar-09
Jun-09
China India
Latin World US Canada UK
America
EZ
Japan World
Trade
The Bad News …. Things Still Look Quite Shaky
2
Financial Market Stress: Not Normal, But Less Systemic Risk
375
130
CA 3m OIS-Libor Spread
Funding markets are
functioning again,
and financial stocks
are outperforming
after two years of
pressure.
MSCI World Financials / MSCI World Index
UK 3m Libor-OIS Spread
350
US 3m Libor-OIS Spread
325
120
JP 3m OIS-Libor Spread
300
EU 3m Libor-OIS Spread
110
275
250
100
225
200
90
175
150
80
125
100
70
75
50
60
25
0
50
06
07
08
09
02
03
04
05
06
07
08
09
Policymakers Went Full Force to Backstop Financial Stability,
They Had No Other Option
Markets Have Been In Risk Seeking Mode For A Lengthy Period
5
Risk Temperature Gauge Variant One
Market Risk Index * LHS
250
Risk Temperature Gauget Variant Tw o
230
4
Risk Aversion
210
3
190
2
170
1
150
130
0
110
-1
90
70
-2
Risk Seeking
-3
Sep-08
50
2000
Dec-08
Mar-09
Jun-09
Sep-09
2001
2002
2003 2004
2005
2006 2007
2008
2009
*Equally -w eighted index of 10-y ear Treasury sw ap spread and VIX
From the peak of risk aversion, markets have been in a lengthy period of risk seeking. There has not really
been a period serious re-examination of the upswing. Even in bull markets, a 90-day period of risk seeking is
lengthy. The current period has been twice that length.
Is A Correction Due?
Trade: Still the Weak Link of the Global Economic Outlook
Many Signs of Improvement, Global Trade Not Yet One of Them
350
Emerging Asia* Exports (US$bn)
20
World Trade Growth y/y (quarterly)
15
300
10
250
200
* China, Hong Kong, India,
Indonesia, South Korea,
Malaysia, Pakistan, Philippines,
Singapore, Taiwan, Thailand
5
0
.
150
-5
100
-10
50
-15
0
Range of estimates of global trade growth in
2009: -9% y/y to -16% y/y. For 2010 estimates
range from 1.0% y/y to +3.8% y/y.
-20
84 86 88 90 92 94 96 98 00 02 04 06 08
72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Concerns About Protectionism Linger
5
How Far Have We Come, How Close Were We To Catastrophe
Japan’s Economy Seemed to Nearly Unravel, South Korea’s Dramatic Trade Slide
80
Japan: Industrial Production (3m
annualized % change)
45
Korea Merchandise Exports (US$ bn)
40
60
35
40
30
20
25
0
20
-20
15
-40
10
-60
5
-80
0
70 73 76 79 82 85 88 91 94 97 00 03 06 09
70 73 76 79 82 85 88 91 94 97 00 03 06 09
Japan came close to the Abyss.
The collapse was absolutely startling
Almost As Spectacular Have Been the Rebounds
6
Economy: Yin and Yang
Fewer States are Contracting, Some Positive Signs, Some Challenging Developments
Philly Fed State Coincident Diffusion Index
80
100
ISM New Orders Index
30
Durable Goods New Orders (y /y )
80
70
20
60
10
50
0
40
-10
60
40
20
0
-20
-40
-60
-80
30
-20
Yawning
Gap
+100 = All States Expanding
-100 = All States Contracting
20
-100
79 81 83 85 87 89 91 93 95 97 99 01 03 05 07
-30
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
According to the Philly Fed, 29 US States are still contracting. That is not great, but in February, all 50 were contracting.
That had never happened before. Other signs of “less bad” developments is the bounce in ISM manufacturing new
orders. However, we have yet to see surveys of new orders morph into actual new orders. Durable goods new orders,
which tend to track ISM MFG new orders closely, have barely started to improve.
7
Things Are Not Getting Worse, But They Aren’t Getting Better Fast
Manufacturing Activity is Rebounding, But Other Signs Point to Lingering Struggles.
105
DJ-BTMU U.S. Business Barometer *
130
ATA Truck Tonnage Index
DoT TSI Freight
120
100
110
95
100
90
90
80
85
70
80
60
75
50
85 87 89 91 93 95 97 99 01 03 05 07 09
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
* Components: Car production, truck production, raw steel production, coal production, electricity output index, railroad carloadings, home purchase index, real weekly chain store sales, box office receipts.
The Recovery is Still Taking its Own Sweet Time…..Much Longer,
And Optimism Will Want Anew
8
The Assault in US Wealth Easing, The Sting to Linger
Sunk Costs and Resetting Expectations for One’s Retirement
10,000
The Tech bubble
collapse was bad for
US wealth.
Change in value of Household Net Worth ($bn, 4qms)
5,000
It can’t hold a candle.
0
-5,000
Bad!
-10,000
-15,000
52
55
58
61
64
67
70
73
76
79
82
85
88
91
94
97
00
03
06
09
That time, the Fed cut
rates to 1% and left
them there for a year.
Change in value of Household Net
Worth (% PDI, 4q ma)
25
20
15
10
5
0
-5
-10
-15
-20
-25
-30
The hit to US
household net worth
from the housing
bubble collapse was
three times longer.
This time, merely
cutting rates was
nowhere near enough.
Worse, Much Worse!
52
55
58
61
64
67
70
73
76
79
82
85
88
91
94
97
00
03
06
09
This is Not the Typical Market Downturn, This Time Really is Different
9
When A Historic Relationship Changes: Either Fundamentals Changed
Equities Have Historically Driven Household Net Worth
A tight historical relationship broke
down in 2004.
Household Net Worth (% of Personal
Disposable Income) LHS
Tobin's Q*
675
250
625
200
575
150
525
100
475
50
425
0
375
52
56
60
64
68
72
76
80
84
88
92
96
00
04
08
Suddenly, US household net worth
was no longer linked with equity
market performance.
Why?
The housing boom, or the housing
bubble.
Suddenly, US household net worth
was linked with housing. The home
as ATM.
That was fine…while it lasted.
The past two years have seen the
historical equity/net worth
relationship reasserted.
In many ways, things are back to
normal, though the adjustment
was painful and disheartening.
Or Fundamentals Eventually Reassert Themselves Violently
10
Fingers Crossed that the Worst of the Housing Downturn is Past
Too Many Carpenters?
2.0
1.0
Single Family Housing Starts (saar, millions)
Single Family Units Under Construction (millions)
1.8
0.9
1.6
0.8
There are some hopeful
signs that the condition of
the US housing market is
no longer deteriorating.
1.4
0.7
1.2
1.0
However, starts remain at
a historic low.
0.6
0.8
0.5
0.6
0.4
0.4
0.3
0.2
0.0
As well, one can presume
that there has rarely been
fewer US houses under
construction, a steep,
steep slide from the 2006
peak.
0.2
59
62
65
68
71
74
77
80
83
86
89
92
95
98
01
04
07
10
Residential Construction Activity Has Not Been This Low in Memory
11
In Some Ways It is the Best of Times for Potential Homebuyers
180
US Housing Affordability Index
20
Freddie Mac: 30-yr FRM
18
Homes are more
affordable than in a
generation
160
16
140
14
Interest rates are at
rock bottom levels …
and there are no teaser
rates surprises in the
fine print.
12
120
10
8
100
6
It is thus not a surprise
to see new and existing
home sales bottoming.
80
4
2
60
73 76 79 82 85 88 91 94 97 00 03 06 09
73 76 79 82 85 88 91 94 97 00 03 06 09
8.0
Even so, signs of
recovery come across as
demostrably tepid.
New and Existing Single Family Home Sales (mns)
7.5
7.0
6.5
6.0
5.5
5.0
4.5
4.0
3.5
95
12
96
97
98
99
00
01
02
03
04
05
06
07
08
Jobs Market: Its Bad, but No Longer Getting Worse
Payrolls Not As Worrisome, But Household Survey Still Cause for Concern
1,500
Nonfarm Pay rolls (Monthly Change 000s)
A staggering pace of job
cuts.
Unemploy ment Rate (16-19 y ear olds)
Prime Jobless (Unemploy ment rate 25-54 y ear olds)
27
It has rarely been more a
more challenging job
market for:
22
1,000
17
12
Youth
7
500
24-54 year olds
2
75
0
-1,000
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08
81
84
87
90
93
96
99
02
05
Priv ate nonfarm pay rolls diffusion index (1-month)
100
90
80
70
60
50
40
30
20
10
0
-500
78
ISM Employ ment (Av g MFG and Non-MFG)
97
99
01
03
05
07
08
75
70
65
60
55
50
45
40
35
30
25
09
Adjusted Household Employment Tumbled by 1 million in August
13
University
Students
Men
Everyone else
US: Never Have So Many Been Unemployed for So Long
A Record 5% of the US Labour Force is Considered Long-term Unemployed
Long-term unemployed (% of total unemployed)
55
55
Exhaustion Rate (12m ma)
50
45
45
35
40
A record 50.7%
in July 2009
35
25
30
15
25
5
20
48 53 58 63 68 73 78 83 88 93 98 03 08
600
Extended Benefits Claimants (thousands)
73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09
3,500
3,000
500
Emergency Unemployment
Compensation (thousands)
2,500
400
2,000
300
1,500
200
1,000
100
500
0
08
09
Up to 13 additional
weeks of benefits
Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09
Skills Deterioration A Risk
14
Over one-half of
those who are
unemployed have
exhausted their
benefits and
moved onto other
programs.
Fiscal and Monetary Policy in US and Elsewhere Responded
Aggressively
Joined Forces to Fight Recession, Less Agreed on What to do Next
US 6m OIS
US 12m OIS
Fed Funds Target
4.5
4.0
3.5
3.0
7.0
6.0
Coordinated
rate cuts
October 8
2.5
2.0
1.5
1.0
Staring into the abyss is a
powerful force to prompt
coordination.
5.0
4.0
3.0
0.5
0.0
Jan-08
AU 6m OIS
AU 12m OIS
RBA Cash Target
8.0
2.0
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
UK 6m OIS
UK 12m OIS
UK Base Rate
6.0
5.0
4.0
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
EU 6m OIS
EU 12m OIS
ECB Repo Rate
5.0
4.0
There is less agreement
on when or how to exit
aggressively easy policy
stances.
3.0
3.0
2.0
2.0
1.0
1.0
0.0
0.0
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
For Exit Strategies Still Theoretical, For Some, An Active Debate
15
Parsing the Fed’s Balance Sheet and the Exit Strategy
The Dramatic Transition
2,400
Treasuries
Repos
TAF+ Dis Window
Agencies
Merrill Lynch
Swap Lines
Other Fed Assets
AIG
PDCF
CPFF
AMLF
MMIFF
MBS
TALF
The first wave —
designed to restore
financial stability and
prevent catastrophe.
The programs were
designed to unwind
naturally as stability
returned.
1,900
Count that a success.
1,400
The more recent
programs will take more
time to unwind. The
Fed’s balance sheet will
eventually decline, but
it will take some work
and it won’t likely get
back to where it was.
USD bn
900
400
Dec-07
Feb-08
Apr-08
Jun-08
Aug-08
Oct-08
Dec-08
Feb-09
Apr-09
Jun-09
Aug-09
Monetary policy and
central banking will be
unrecognizable in a few
years.
USD — What’s Next As the Mad-Dash to USD Fades?
Still a Premium on USD Funding, But Well Off Peak … So is USD
20
90
0
88
-20
86
What Next?
84
Tension was building all
Summer.
-40
USD back to preLehman levels.
DXY Index
82
-60
80
Was the next move to
be upward….
-80
78
-100
76
-120
-140
Or downward.
74
EUR 1-y r cross currency basis sw ap
Market seems to have
made up its mind.
72
GBP 1-y r cross currency basis sw ap
-160
Jan-07
70
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jun-08
Sep-08
Dec-08
Mar-09
Jun-09
Sep-09
US: Deflation Risks Have Declined, But Inflation … Not There Yet
Unlike the 1990s, the Global Backdrop is Not Set to Help the Fed Control Inflation
Is Deflation set to occur?
Is Inflation set to explode?
4.0
3.5
US Core Goods 5-yr annualized % LHS
3.5
US 5yr/5yr Forward Inflation Expectation %
3.0
3.0
Core goods prices reflected
disinflation in 1990s and
deflation risks in 2002-2003.
2.5
2.5
Age of
Disinflation
2.0
2.0
They are not on the way up,
but won’t ring inflation alarm
bells for some time.
1.5
1.5
1.0
1.0
0.5
Meantime, while longer-term
deflation fears were credible
late last year and into 2009,
they have dissipated.
0.5
0.0
0.0
-0.5
-0.5
-1.0
90
92
94
96
98
00
02
04
06
08
Neither deflation nor rampant
inflation seem likely in the
next few years.
07
08
09
Long-term inflation
expectations are back near
historic norms.
When Can the Fed Be Sure that Deflation Risks Have Passed and that
It is Time to Wind Down QE Programs?
18
Global Markets and the China Effect
Global stocks on a roll, but the indicators of shipping activity have faded, after a China-led pop
China copper imports
(thousand tons) RHS
10500
8500
Baltic Dry Index LHS
57500
13000
12000
11000
10000
MSCI Emerging Market Equity Index
(Local Currency) RHS
Yawning
Gap
52500
47500
8000
7000
6000
350
4500
275
2500
200
500
125
70
03
04
05
06
07
08
09
China Imports of Iron Ore & Concentratess
(million tons)
50
40
30
37500
5000
4000
6500
60
42500
425
Copper (US$/lb) LHS
02
9000
500
20
10
0
02
32500
03
04
05
06
07
08
09
05
06
07
08
09
3000
500
2000
27500
1000
0
Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09
China Imports of Aluminum
(thousand tons)
400
300
22500
200
100
0
02
19
03
04
A Staggering and Sobering Erosion in US Fiscal Backdrop
Foreign Investors Snapping Up Record Volume of Treasuries…Can’t Keep Up With Supply
400
US Federal Deficit (US$ bn, 12mms)
200
0
-200
-400
Foreign investors
purchased a record
US$756bn of Treasuries
(4Q total) to Q1.
-600
-800
-1,000
US$1 trillion
-1,200
-1,400
Issuance totalled
US$1.5tn.
-1,600
75
78
81
84
87
90
Treasury Issuance (US$bn, 4qma)
2,000
93
96
Foreign Purchases of Treasuries (US$bn, 4qma)
1,500
1,000
1,000
500
500
0
0
-500
-500
70
75
80
85
90
95
00
05
02
05
08
Treasury Issuance (US$bn, 4qma)
Domestic Purchases of Treasuries (US$bn, 4qma)
2,000
1,500
99
70
75
80
85
90
95
00
US Domestic investors
stepped in, the first
major foray into the
Treasury market in over
a decade.
05
The CBO and the White House Indicate that the Federal Surplus Will Top US$9tn
Over the Next Decade…… US$9 Trillion
20
Foreign Investors Now Primarily Interested in Treasuries
500
US Treasuries (12-m ms)
95
However, foreigners have
modified what they buy.
Foreign Holdings of US Treasuries
held in longer-term securities (% of
total)
400
In the past, they had a
strong preference for
longer-term Treasuries,
which used to make up
90% of foreign holdings.
90
300
200
85
There has been a dramatic
shift toward Treasury bills.
100
80
Long term Treasuries now
account for 75% of
holdings.
0
75
-100
-200
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
70
01
02
03
04
05
06
07
08
09
This occurred even though
foreigners were heavy
buyers of Treasuries, but
reflected lingering concern
about heavy US deficits.
A Shake Out of Global Finance
Foreign Investors Revealed Preference — They No Longer Like US Corporates or Agencies
600
550
Net Foreign Purchases of US Corporates
(USD bn, 12m ms)
400
US Agencies (12-m ms)
300
500
450
200
400
Net inflows into these sectors
were near US$850bn in June
2007, and had helped fund
the US current account deficit
and thus global imbalances.
350
100
300
250
0
200
150
-100
They have turned into net
seller of both sectors.
100
50
-200
0
-50
-300
78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08
Over much of the past
decade, foreign investors were
heavy buyers of US corporate
debt (largely ABS), and
Agencies.
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Lingering Imbalances in the Global Economy
Increasingly Unsustainable
US (consumption, share of GDP)
51
US Share of G7 GDP (%) LHS
8
US Current Account Deficit (% GDP) RHS
72
50
6
49
70
48
68
4
47
66
46
2
45
64
44
Yawning
Gap
0
62
43
60
42
61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06 09
So long as spending does not
depend on wealth, income, jobs,
or credit …. This is fine
23
-2
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Atlanta Fed President
Lacker notes that the US
consumer has been
traumatized.
One might wonder what he
is talking about.
In 2009 Q2 consumption’s
share of GDP hit a record
high, well above levels seen
in 2004 to mid-2007 a
period of housing bubbleinduced spending.
US consumers are not going
to disappear, but the US
economy has to become
less dependent on the
consumer.
So too, the overall G7
economy is still too
dependent on the US, and
thus on the US consumer
too.
US 10-Year Yields, Not Doing Much to Attract Interest
US GDP (%, 10-y ear annualized)
18
10-y r Treasury Yield %
10-year Treasuries closer to 4% is reasonable
based on the long-term growth rate of nominal
GDP.
16
14
12
10
8
6
4
2
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
95
97
99
01
03
05
Fear of Loss Might Do More To Prompt Support
07
09
Exit Strategies: Whose First, Whose to be Last
Trying to Find the Right Route
US 6m OIS
US 12m OIS
Fed Funds Target
4.5
4.0
3.5
3.0
7.0
6.0
2.5
5.0
2.0
1.5
4.0
1.0
3.0
0.5
0.0
Jan-08
AU 6m OIS
AU 12m OIS
RBA Cash Target
8.0
2.0
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
UK 6m OIS
UK 12m OIS
UK Base Rate
6.0
5.0
4.0
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
EU 6m OIS
EU 12m OIS
ECB Repo Rate
5.0
4.0
3.0
3.0
2.0
2.0
1.0
1.0
0.0
Jan-08
0.0
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Central Bankers Have Few Rulebooks for What They Are (Still) Up Against
25
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Employees of RBC Capital Markets are expressly prohibited from offering directly or indirectly a specific price target, or offering
or threatening to change research, a rating or a price target, to a company as inducement for the receipt of business or
compensation.