2009 outlook: deep recession, no recovery until 2010 and lower Treasury yields

The pessimistic outlook for 2009 flows from the prospect of a continuing and deepening recession. US real GDP is expected to decline an horrendous 4% to 6% in both the fourth quarter this year and the first quarter next year. For the full year 2009, US real GDP is likely to be down some 2% to 3%, a precipitous decline.

The US recession will continue to be reinforced by a worsening global economic and financial decline. The prodigous efforts to stimulate the economy here and abroad and bailout bankrupt or beleagured financial institutions and auto companies may avoid a worse adjustment. But, it is not enough to reverse a generation of excesses. The deleveraging process still has much further to run, especially among hedge funds and individuals among other sectors.

The economic turnaround is likely to be delayed for an extended period, probably until Spring 2010. By that time home prices are like to drop another 15% to 20%, enough to make homes more affordable relative to average personal income. It will probably take that long to significantly trim the burdensome 11 months overhang of unsold homes at the current sales pace, particularly with a coming wave of additional forclosures with mortgage resets. But, there is far more to this recession than just the debacle in housing and housing finance. There is also a consumer led recession, a bursting of an unbridled credit bubble producing a pronounced credit contraction, a bursting of a commodity bubble, and soaring unemployment that is likely to exceed 10%, among other virtually unprecedented problems.

This week the Fed cut the Federal Funds to between zero and 0.25%. Even more significant, the Fed indicated that it would use every option, essentially whatever it takes, to reverse the recession. The Fed also indicated that it would expand its lending programs to bring down interest rates, especially on mortgages. In addition,the Fed is considering buying longer-term Treasuries. These Fed rate levels and actions are projected to persist all through the year ahead.

Those various steps and the prospect of further supportive actions were instrumentalal in driving Treasury yields to new lows. The yield on 30-year Treasuries fell to 2.55% at weeks end from 3.33% the week before and 4.22% in mid-November. The yield on the Treasury 10-year fell to 2.13% from 2.33% the week before. But the Fed's actions were intended to accomplish more than just reduce yields on Treasuries. They were intended to drive yields down enough to encourage risk taking and hopfully lending, especially including mortgage lending.

While there is an increase in mortgage applications, there no evidence of a pronounced increase or willingness of banks or other instutions to lend for other purposes. However, there has been a decline in market yields on medium to high-grade corporate bonds. For example, the AAA-rated 6.75% GE bonds of 2032 declined in yield to 6.1% from 7.4% as recently as the beginning of December, even though Standard & Poors put the issuer on negative review, suggesting a possible rating downgrade. The yields on lesser grade bonds, such as A-rated credit quality bonds, also improved this week. That was true even of the 11 banks that Standard & Poors actually did downgrade this past week.

It is my view that bond yields will continue to decline through the year ahead, though not in staight line. The expectation of still lower bond yields partly reflects projected deflation. The year over year official consumer price inflation rate is rapidly headed in that direction. Nevertheless, the consensus forecast of most economists expects a rise in Treasury bond yields both by midyear and a further rise by yearend.

Equity prices are up considerably from their lows and may well rise further early in the new year, perhaps even for as long as into the Spring. However, the severity of the recession and the surprising weakness of corporate earnings (an averager per share of some $55 for the S&P 500)will likely lead to at least a retest of the old price lows. Indeed, it is quite possible that new price lows will be established before there is a solid equity price recovery late next year.

My next blog is scheduled for January 3, 2009. Happy Holidays and best wishes for a happy new year.

Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731

Email address:philipbraverman@Gmail.com