The National Outlook

Highlights

• The contraction in economic output (real GDP) slowed considerably in the second quarter and available data point toward resumption of positive growth in the third quarter of this year. It's now likely that the official end to the "Great Recession" lies somewhere within the current quarter, although the decision about exact timing won't be announced for some time.

• The housing production component of GDP, residential fixed investment, is part of the imminent swing from negative to positive economic growth, thanks partly to the temporary $8,000 federal tax credit for first-time homebuyers. The troughs in home sales and housing starts occurred in the first quarter, and RFI should make a positive contribution to GDP growth in the third quarter of the year.

• Systematic recovery of consumer spending is essential to sustainable economic expansion. Recent Federal Reserve data indicate key improvements to household balance sheets in the second quarter, a prerequisite to durable recovery of consumer spending. While further deleveraging by households is in store, the drags on spending from negative wealth effects and heavy debt burdens have begun to ease.

• The labor market continues to deteriorate, even as economic output is on the rise, and that pattern figures to persist over the balance of the year. However, the rate of deterioration is slowing, payroll employment growth should turn positive by early 2010, and the unemployment rate should top out at about the same time. Subsequent improvements most likely will be gradual, leaving considerable slack in labor markets for an extended period.

• The inflation picture continues to improve, and there's still a threat of outright deflation in the U.S. economy. We expect key measures of core inflation to move down further, even as the economy recovers, due primarily to remaining slack in resource markets. Indeed, core PCE inflation already is slipping below the Federal Reserve's apparent target range and could even slip into the red zone by 2011.

• The Fed held monetary policy steady at the conclusion of the September 22-23 FOMC meeting, maintaining the rock-bottom target for the federal funds rate and reinforcing targets for purchases of housing agency debt and MBS as well as Treasury securities. The Fed most likely will maintain a highly stimulative monetary policy stance as long as unemployment is high and inflation is low, a condition that's likely to persist for nearly two years. And we're not overly concerned about Fed asset sales out of portfolio in the near term, even though key purchase programs will be winding down by early next year.

• Financial market conditions continue to improve, following the unprecedented global turmoil that erupted last fall. Key credit risk spreads are back in normal ranges, or converging toward those ranges, at least for high-quality private instruments. In this regard, the spread between rates on prime conforming fixed-rate mortgages and 10-year Treasury securities still is narrowing, and we expect further progress on that front during the next two years.

• Housing market activity already is off the deck, at least in the single-family market. However, the near-term outlook is bumpy and the intermediate-term outlook is subdued--at least in the context of the record-breaking contraction that bottomed out early this year. Our projections for 2010-2011 elevate overall housing production (residential fixed investment) to levels that prevailed just before the unsustainable housing boom got underway in 2003.

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