Sunday, February 14, 2010

U.S. Economic Report- 02/14/10

2010 U.S. Economic Outlook: USD Implications

Growth Coupled with Dollar Strength

•The USD has room to strengthen against all G10 currencies since those currencies were overvalued against the USD by an average of 5.6% in 2009

•The U.S. economy grew by 5.7% in the 4th quarter of 2009 as interbank spreads narrowed, Equity, and corporate debt markets have rallied signaling a stronger dollar and return to normal growth

•Industrial output declined by 970 basis points in 2009,but is forecast to grow by 620 basis points for the year 2010, thus signaling a rebound in manufacturing and perhaps job creation

Inflation Story

•The U.S. Treasury, Federal Reserve, and FDIC have pumped enormous amounts of Liquidity into the Capital markets throughout the Great Recession in the form of Tarp, Stimulus Packages, PPIP, Legacy Securities Program, TALF

•The BOE and ECB are likely to tighten monetary policy before the FOMC because The U.S. federal Reserve will most likely keep interest rates unchanged in 2010 due to The Committee’s responsibility of handling Inflation and Unemployment

•Consumer Price Index Inflation declined by -0.4% in 2009 and is expected to increase to an average of 2.1% in 2010

Unemployment and Fiscal Deficits

•United States unemployment peaked in 4th quarter of 2009 at 10.0%, with nearly 8.4 million people out of work since the beginning of The Great Recession. The unemployment rate for 2009 was 9.28% and is expected to grow to 9.60% in 2010

•The Current Account deficit as a percentage of GDP widened to -3.0% in 2009 and will amplify to -4.0% in 2010

•The 2009 budget Deficit in the U.S. is expected to be $1.42 trillion which represents 9.98% of Gross Domestic Product

USD Drivers

Balance of Payments
The U.S. maintains a current account deficit of -3.0% as a percentage of GDP and is expected to grow to 4% in 2010. This can be attributed to 2009 net exports of -354 Billion. Also, the U.S. sees investment inflows into their equity and debt markets to offset such a large trade gap. China invested $790 billion in U.S. Treasuries as of November 2009. Fundamentally, this goes a long way of explaining long-term dollar weakness.

The United States Economy grew by 20 basis points in 2009 boosted by 4th quarter GDP output of 5.7%. This signals a return of demand to the world’s largest economy. Much of the growth story can be attributed to the excess liquidity put into the system by the Fed’s quantitative easing programs and government stimulus package. Additionally as The S&P 500 rallied 70% off the lows of March 2009 to January 2010, consumers have reason to spend as their net wealth increases even in the face of continuous declining real-estate values. In addition, Industrial output surged 700 basis points in the 4th quarter of 2009 to contribute to GDP growth. However, one caveat remains; U.S. unemployment remains at 9.7% currently and is expected to be flat with moderate increases/decreases in 2010. It is hard to justify an economic recovery without job growth. Though the Euro area has greater difficulties with unemployment.

The 2009 budget Deficit in the U.S. is expected to be $1.42 trillion, which represents 9.98% of Gross Domestic Product ($14 trillion). Careful maneuvers will decrease the 2010 fiscal deficit to $1.14 trillion or 8.02% of GDP. According to John Maynard Keynes deficits can be have a positive economic influence by helping economies climb out of recession.

The United States saw deflation in 2009 as CPI decreased by 40 basis points on average. Inflation is expected to pick back up in 2010 by 2.1%. However, the Federal Reserve will surely act quickly to spur inflation. The lesson was learned last go around when Alan Greenspan kept The Fed Funds rate at low for a historic period. This helped fuel the Credit crisis. Additionally, tightening monetary policy would increase the value of the dollar global and kill any potential dollar carry trade.

Interest Rate Differentials
Currently a 10 Year U.S. Treasury yields a nominal rate of 3.625% and a real rate after inflation is accounted for of 3.925%. The U.S. nominal 10 year rate beats out 10 year German Bunds yielding a nominal rate of 3.25% and 10 year Japanese Government Bonds with a nominal rate of 1.3%. Also, Bunds and JGB on average yield real rates of only 2.95% and 2.6% respectively. This has positive implications for dollar strength.

Patrick M. Ambrus
Managing Partner
Analyze Capital LLC

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