Recovery at a Snail’s Pace
Double-dip or not, 2011 will be a year of slow economic growth, say CUNA's economists.
Economists have debated the possibility of a double-dip recession ever since the economy went into a free-fall more than two years ago. One opinion is that waiting to tackle the deficit could result in a bond market crisis. That would spur a double-dip recession, according to former Federal Reserve Chairman Alan Greenspan in an interview on “Meet the Press” in mid-November.
“We have to resolve this issue before it gets forced upon us,” said Greenspan. His fear is that the long-term deficit could “spook” the bond market “to a point where long-term interest and mortgage rates move up very sharply. If that happens, that will cause the double-dip.”
Current Fed Chairman Ben Bernanke also lowered projections for the 2011 economic outlook, with forecasts of a slow economy and only gradual improvement in the job market.
Still, both economists say a double-dip recession is unlikely, as recent signs show the economy is slowly recovering, along with the economies of other countries.
The Fed’s plans
The effects of the Federal Reserve’s plans for additional “quantitative easing”—purchasing $600 billion in long-term Treasuries through midyear 2011, and reinvesting an additional $250 billion to $300 billion in Treasuries—are still largely unknown, says Mike Schenk, vice president, economics and statistics, for the Credit Union National Association (CUNA).
Quantitative easing could have negative and positive effects on the economy, he says. While it “increases the money supply by flooding financial institutions with capital to promote increased lending and liquidity,” he says, “the major risk is that it could eventually lead to higher prices and inflation.”
The potential effects of quantitative easing, says Schenk, include:
• Potential increases in lending, spending, and growth. But since households remain overextended with debt, it’s unlikely to stimulate significant amounts of consumer borrowing.
• Lower long-term interest rates might cause more mortgage refinancing, leaving households with more income to spend on other things.
• Lower interest rates should soften the blow of adjustable-rate mortgage adjustments—increasing discretionary income and lowering the risk of additional foreclosure activity.
• Lower interest rates should encourage businesses to make more capital investments, which would boost economic activity and lead to future productivity gains.
• Increased risks of inflation and hyperinflation.
• The risk that expectations have changed. In other words, quantitative easing might cause some housing market activity to stall, since people might be expecting even lower rates sometime in 2011.
“Quantitative easing isn’t necessarily all good,” says Schenk. “It results in changes in behavior and expectations, and this can be a problem from an economic perspective.”
Double-dip or not, 2011 will have its share of challenges, says Schenk. The biggest ones will be:
• Prolonged weakness in labor markets, with unemployment hovering around 10%;
• Households continuing to pay down debt and reluctance to borrow; and
• Austerity and the threat that government stimulus programs will end before labor markets have significantly recovered.
While U.S. economic growth won’t return to what it was in the 1980s and 1990s, “private sector job growth will lead to a self-sustaining expansion in 2011 with the economic growth rate rising to 2.5%,” says Schenk.
All trends, positive or negative, will move at a snail’s pace, he adds, largely because of high unemployment and modest consumer spending. Many consumers continue to harbor significant concerns about their personal finances.
Other forecasts from CUNA’s economists include:
• Core inflation will remain below the Fed’s implicit inflation target of 2% through 2011. Core inflation (excluding food and energy prices) will remain below its historical average, reflecting the weak state of consumer demand and the economic expansion. Low core inflation is keeping inflation expectations low and therefore also keeping long-term interest rates low.
• The federal-funds interest rate won’t begin an upward path until the end of 2011, if then. Labor and credit market conditions will be the major factors influencing the Fed’s decision to raise interest rates. It will wait until loan demand picks up and the unemployment rate falls before beginning its exit strategy from quantitative easing. Expect a 25-basis-point interest-rate increase at the end of 2011, but only if the labor market improves significantly.
• The 10-year Treasury interest rate will hover around 3% in 2011. Three factors have caused its recent decline: the Euro-Zone debt crisis, the Fed’s quantitative easing, and fears of a double-dip recession. These factors will become less influential through 2011, pushing up long-term interest rates.
• The Treasury yield curve should remain fairly steep through 2011, since the Fed is expected to keep short-term interest rates low, and long-term rates will change only modestly.
Next: What to expect in 2011
What to expect in 2011
While credit unions will face some of the same challenges as other financial institutions in the year ahead, they also have some unique opportunities. CUNA’s economists predict:
• Loan demand will remain weak. Loan balances declined in 2010 for the first time since 1980 because members paid off debt and credit unions sold mortgages and charged off loans. Members paid off debt rather than saving additional surplus funds due to the large interest-rate differential between loan and deposit interest rates. Loan growth will increase to about 4% in 2011, which is below its recent five-year average of 6.8%.
• Capital-to-asset ratios will continue to decline. Earnings and thus capital contributions will not keep pace with asset growth, marginally lowering net worth ratios.
• Delinquencies will trend down, but remain above historical levels because of the high unemployment rate.
• Low market interest rates and a relatively steep yield curve should help boost credit union bottom lines.
• Marginal improvements in labor markets should translate into higher credit union asset quality and lower loan loss provisions.
• More quantitative easing by the Fed should increase opportunities for growth in mortgage refinancings.
• Savings growth will stabilize. After posting strong savings balance growth of 10.6% in 2009, credit union members’ spending and saving behavior will shift back to normal during the next few years. Savings growth will be 6% in 2011 as members continue to focus on repairing their balance sheets.
• Credit quality will turn the corner and start to improve because of decreasing delinquencies and lower loan loss provisions.
• Credit union return on assets will recover to about 0.5% this year. Lower loan loss provisions, rising net interest margins, and cost containment efforts will boost credit union earnings from 2009’s historic low of 0.07%.
“The past few years have been incredibly difficult for most credit unions,” says Schenk. “The good news is, we’re definitely and firmly in recovery mode and next year promises to be better. But this recovery won’t look like the turnarounds we typically experience after economic downturns. The pace of improvement will be slow and steady.”