The Economic Recovery Continues

Excerpt from Annual Economic Outlook 2010 from Economics Group, Wells Fargo Securities LLC

Economic forecasting, like sailing, requires constant adjustment to changing winds, currents and the occasional hazard. While the worst of the storm has passed, our ship is still struggling against fierce winds. We are far from an equilibrium point in the economy. We continue to anticipate subpar growth in 2010, with both the pace and composition of the expansion being very different than what we are used to or what we may wish. The pace of the expansion is characterized by real growth of 2.2 percent in 2010 with inflation at just 1.8 percent.

Positive contributions to growth will likely come from rising consumer spending, business investment—particularly equipment and software, housing and of course, federal spending. Improved consumer spending will reflect the upturn in real personal income due to eventual job creation, a longer work week and rising wages. We expect real incomes to benefit from continued low consumer inflation. Business investment should improve as financing costs remain low and business expectations of final sales improve. Corporate profits will likely grow, which would improve cash flow and provide liquidity for business investment. We expect housing to continue its recovery as income and consumer confidence improve demand and housing finance continues to be supported by low interest rates. Our forecast shows the federal spending stimulus will continue to be applied in the first half of next year and will only gradually begin to slow in the second half as election-year imperatives take over. As for trade, global growth and the weak dollar will stimulate exports but rising domestic consumption and increased energy prices will temper some of the positive effects.

Also putting a damper on hopes for a swift recovery are both the disappointing outlook for housing and the slow growth in consumer spending. For our society, the modest pace of expansion implies only slow improvement in the labor market with the unemployment rate remaining high. We expect sustained positive monthly payroll numbers will start to appear in the late spring of 2010.

Already, we sense that the convergence process to a new economic equilibrium has been more difficult than policymakers estimate. Job growth has been non-existent. Credit growth has been restrained and the recovery in housing far less significant than expected. Still, inflation remains subdued as unemployment limits the acceleration in wages and unit labor costs. Our central tendency for inflation, as measured by the Consumer Price Index (CPI), is 1.5 to 2.0 percent. Slow real growth will run into political pressures in the year ahead as economic realities fall short of political rhetoric. Finally, concerns remain about the long-run pace of growth in the economy as well as the ability of the recovery to sustain itself at a pace that meets the expectations of consumers and workers especially as an election nears. It is not clear how much of the recent economic upturn can be sustained without government support. Recent improvements in business surveys and capital goods orders may have peaked, at least near term. The remaining downside risks reflect weakness in the labor market, with implications for income growth and consumer confidence.