A question of sustainable growth
At present, there is enough policy-fueled growth momentum to see the economy grow over the next 12 months. The big question is what happens in 2011 and 2012, when government stimulus has faded and interest rates are on the rise. The sustainability of growth momentum into 2011 and 2012 will depend on a careful and well-designed exit strategy by governments and central banks. Current evidence suggests that they appear to be on the right track.
Robust rebound unlikely
Unlike previous recoveries, the U.S. consumer is unlikely to be a recovery driver. Nominal wage gains will be smaller, credit will remain tight, the savings rate will stay high, new hiring will be slow to materialize and consumer confidence is still weak. As a result, the growth in the U.S. economy will be lower than what is normally expected in the first year of recovery from a recession. Real GDP is expected to decline from about 3% in the second half of 2009 to around 2.0% in the first half of 2010.
Better than expected earnings have supported the revival in stock markets but this rebound may be unsustainable. The positive earnings surprises that helped sustain the rally were largely the result of cost cutting. Future earnings growth will need to come from increased revenues, not all that likely with slow economic growth.
Jobs growth needed
If new hiring in the U.S. does not appear in 2010, the economic recovery will be threatened. Fortunately some leading indicators for the U.S. job market are finally looking better. Employment in temporary services has increased for four consecutive months and average hours worked is on the rise. Still, a major job creation effort is needed as well as more assistance for state and local governments. But concern over the size of U.S. public debt and a return to fiscal responsibility early in 2010 may limit the size of any new fiscal help.
Inflation anxiety evident
General inflation will not heat up in 2010 – wage and salary growth is just too weak. However, there will be enough-sector specific inflation – commodities such as oil and copper, for example – to create inflation anxiety in the financial markets. Long-term bonds are already showing inflation awareness as the yield curve in the U.S. has become very steep. The current spread between U.S. 90-day Treasury bills and 10-year Treasure notes is at 377 basis points.
The rebound in commodity prices is at least a year ahead of schedule based on previous business cycle experience. The oil market is expected to tighten in 2010 and the upturn in base metals prices partly reflects strategic stockpiling by China.
Growth in Canada constrained
Although fiscal stimulus in Canada will move into high gear in 2010, economic growth will be constrained by a number of factors. Canadian exports will lag because of the weak U.S. recovery and elevated Canadian dollar. Housing will be a recovery leader but non-residential construction will continue to decline. Companies will not spend aggressively on equipment and machinery and after a good Christmas retailing season, consumer spending will be slowed by decelerating disposable income and an increased propensity to save. The household debt to income ratio for Canadians is at a historic high. The continued strength of the Canadian dollar, contained inflation and the impact of rising interest rates on household finances and the fragile nature of the economic recovery will likely keep the Bank of Canada from raising interest rates anytime soon.
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