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ôIt is a schizoid financial climate,ö Western Asset says in a report. ôInvestors have bid credit spreads to extremely elevated levels, suggesting protracted problems for the housing market and the economy while financial futures have priced in Fed tightening by next summer, suggesting expectations of a marked rebound in economic growth soon.ö
Western Asset disagrees with those consensus outlooks. The fund house believes economic growth will continue in a relatively tight channel between 1% and 2%, with the economy skirting recession but also failing to generate a pronounced or prolonged rebound.
The main reason recession should be averted is that the drag on GDP growth from homebuilding is in the process of ceasing. Once housing construction bottoms out, the drag will disappear, thus, dramatically lessening the chances of recession, Western Asset says.
ôOn balance, the US economy still faces downside risks in the near-term. However, the major downside reality is fading,ö says Western Asset. ôEven accompanied by plunging homebuilding, these other downside factors have yet failed to drive an outright recession. Opposite flat homebuilding, other factors would have to deteriorate dramatically to drive a recession, and we think this quite unlikely.ö
While the economy has avoided outright recession, growth has continued below potential for over two years, and economic slack has built up both in terms of higher unemployment rates and lower capacity utilisation rates in industry, among other things.
Eventually, the economy will embark upon a recovery from this period of sub-standard growth, Western Asset says, but this recovery will likely proceed very slowly.
Western Asset identifies its reasons for expecting no boom scenarios in the US in the coming years.
First, the consumer is ômaxedö. In the absence of further Fed or fiscal stimulus and with consumption and income ratios already near historical highs (consistent with zero saving rates), there is little scope for consumer spending to rise faster than personal incomes in a coming recovery.
Second, supply, demographic, and speculative factors are working against housing. Consumer spending could rise rapidly if personal incomes start growing rapidly, but some other sectors of the economy will have to rebound in order to drive that. Looking at the other sectors, while homebuilding is likely to cease declining imminently, driving a rebound will be another story.
Third, capital spending is still restrained. Surging capital spending helped drive strong economic growth in the late 1990s and that boom generated a glut of equipment and capacity which still has not been fully worked off. On top of this, it is most unusual for capital spending to surge early in an expansion anyway, as that is when capacity utilisation rates are at their lowest, with little or no need for more capacity.
Fourth, budgets, exports and supply-side are significant factors. Current fiscal deficits at the federal and state and local levels make major government spending programmes most unlikely. Financing such programmes via higher taxes would blunt their possible macroeconomic impact. In order to single-handedly drive a booming recovery, US exports would have to grow at something like a 20% annual rate, such as was experienced in the late-1980s.
Western Asset is one of the worldÆs leading money managers with more than $624 billion in assets under management. Legg Mason, its parent, is one of the worldÆs largest global investment management firms with assets of more than $950 billion.
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