–Maybe ‘Wide Spectrum’ Maturities Buys if Econ Gets Worse
–Slow Growth Leaves Economy Vulnerable to Downside Shocks
WASHINGTON (MNI) – The following are excerpts from the remarks of
Federal Reserve Vice Chairman Janet Yellen prepared Friday for the
Annual Meeting of the Financial Management Association International in
Denver:
I will begin by pointing out that, although the U.S. economy
continues to grow, the recovery has been proceeding at a disappointingly
slow pace. Moreover, slow growth leaves the economy vulnerable to
downside shocks, such as the potential for adverse developments in
global financial markets.
—
The pace of the economic recovery has been less vigorous than any
of us would have desired and than most forecasters had anticipated.
Indeed, recent revisions of economic data by the Commerce Departments
Bureau of Economic Analysis indicate that the recession was deeper, and
the recovery weaker, than previously estimated. Since the beginning of
the recovery in the third quarter of 2009 through the second quarter of
this year, the most recent quarter for which an estimate is available,
real gross domestic product (GDP) expanded at an average annual rate of
about 2-1/2 percent, a slower pace than during the first two years of
most U.S. recoveries in the past half-century. As a consequence,
aggregate output in the second quarter still had not reached its peak
level just prior to the recession. Not surprisingly, the unemployment
rate has declined only 1 percentage point from its high of about 10
percent near the end of 2009, and the number of jobs in the private
sector remains more than 6 million below the peak level reached in early
2008. The fraction of those now jobless who have been without work for
six months or more stands at a very high level. And, in addition to
those officially unemployed, many individuals are involuntarily working
part time or have dropped out of the labor force entirely.
U.S. economic growth was particularly anemic in the first half of
this year, when real GDP rose at an average annual rate of less than 1
percent. Two factors, both largely transitory, played a notable role in
depressing growth and in boosting inflation during the first half of the
year. First, sharp increases in the prices of oil and other commodities
eroded the purchasing power of households incomes, thus restraining
their spending. Gasoline and food prices surged, and a portion of
producers higher input costs were passed through to the prices of a
wide range of consumer goods and services. Second, the production and
sale of motor vehicles declined sharply because of disruptions in global
supply chains in the aftermath of the disastrous earthquake and tsunami
that struck Japan last March. These supply disruptions also limited the
availability of some popular models, placing upward pressure on motor
vehicle prices.
Fortunately, commodity prices have come down from their earlier
peaks, which should ease pressures on consumer prices and, in turn,
lessen strains on household budgets. Automotive supply chain disruptions
have also diminished in recent months, resulting in a rebound of both
the production and sales of new motor vehicles. Partly for these
reasons, it looks likely that economic growth in the second half of this
year will be noticeably stronger, and inflation more moderate, than in
the first half. Unfortunately, however, a range of other, more
persistent factors also appear to be restraining the recovery. Moreover,
financial market conditions have deteriorated, on net, in recent months,
intensifying some of the headwinds facing the economy.
Persistent Restraints on the Economic Recovery
The average pace of consumer spending during the past several
quarters has been weaker than can be explained by the transitory factors
that I just mentioned. High levels of unemployment and underemployment,
slow gains in wages, and declines in the values of both homes and
financial assets have weighed on household spending. Households appear
to have made some progress in deleveraging, but many still face elevated
debt burdens and reduced access to credit. Moreover, consumer sentiment
dropped markedly over the summer and has remained low since then,
reflecting households concerns about the broader economy as well as
their own financial situations.
Weak consumer spending, unsurprisingly, increases concerns among
businesses about the prospects for sustained growth in the demand for
their products and services. As a consequence, many businesses have been
reluctant to significantly expand their payrolls. Indeed, the average
pace of hiring during the past several months has been quite a bit
slower than earlier in the year. As a result, the unemployment rate has
continued to hover in the vicinity of 9 percent since early this year.
Furthermore, recent surveys have shown some deterioration in firms
hiring plans, and new claims for unemployment insurance by workers who
have been laid off remain relatively high.
Such indicators are consistent with job gains remaining tepid in
the coming months. A sharp downturn in housing was at the core of the
recent recession, and this sector continues to weigh on the recovery.
Robust increases in housing activity have helped spur recoveries from
most U.S. recessions in the past 50 years. This time, in contrast,
residential construction remains depressed by a large inventory of
foreclosed and distressed properties, tight credit conditions for
construction loans and mortgages, concerns about further declines in
home prices, and the substantial number of homeowners whose mortgage
balances exceed the values of their homes. As a result, new home
construction currently is at only about one-third of its average pace in
recent decades.
—
Financial Markets and Institutions
Turning to financial markets, I noted that conditions have improved
since the depths of the crisis, but obvious strains remain, some of
which have intensified in recent months. Since the early summer,
financial markets have been experiencing an unusual amount of
volatility, and investors have pulled back from risky assets on balance.
The result has been lower equity prices, wider risk spreads on corporate
bonds and many other debt instruments, and greater pressures on
financial institutions. At the same time, heightened demand for safe
assets has put downward pressure on Treasury yields and boosted the
foreign exchange value of the dollar. These developments partly reflect
the response by investors to news about the U.S. outlook that has, on
net, fallen short of their expectations, as well as a recognition that
growth is slowing elsewhere in the global economy. But they also reflect
anxiety in financial markets about the fiscal problems in Greece and
other euro-zone countries, along with greater sensitivity to the
exposures of the European banking system to troubled sovereign debt.
European leaders are strongly committed to addressing these issues and
have begun to make some progress on them, but the need to obtain
agreement among a large number of euro-zone countries to be able to put
in place necessary backstops, as well as difficulties involved in
addressing the fiscal imbalances in some of these countries, has slowed
the process of developing and implementing solutions. At this time, it
is difficult to know just how much these developments in global
financial markets have affected U.S. economic activity thus far.
But, looking forward, particularly worrisome is the possibility
that U.S. financial institutions facing earnings or funding pressures,
in part as a result of the problems in Europe, could cut back on
lending, tighten credit terms, or attempt to delever by rapidly selling
off assets. Indeed, recent surveys suggest that the trend we had been
seeing of increased availability of credit and easing of terms among
dealers may have been interrupted. A significant deterioration of the
U.S. economic outlook, of course, would place financial institutions
under additional stress. The potential for such adverse financial
developments to derail the recovery creates, in my view, significant
downside risks to the outlook.
—
Importantly, I see little indication that the higher rate of
inflation experienced so far this year has become ingrained in the
economy. Longer-term inflation expectations have remained stable
according to surveys, and market-based measures of inflation
compensation are still subdued; measures derived from yields of Treasury
inflation-protected securities (TIPS) suggest that expected inflation
over the next five years currently is around 1-3/4 percent. The
substantial amount of resource slack that is projected to remain in U.S.
labor and product markets over the next several years, coupled with
sustained growth in productivity, should continue to restrain the growth
in labor costs, helping to contain inflationary pressures. In fact,
there is a risk that disinflationary pressures could intensify if the
recovery faltered. Indeed, based on imputations from TIPS prices, market
participants assessments of the odds of outright deflation have risen
significantly in recent months.
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** Market News International Washington Bureau: 202-371-2121 **
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