The consensus of economic forecasters expects 2010 to be a year of modest economic growth — almost 3% — much better than the previous two years. But that’s not good enough to bring unemployment — the greatest continuing threat to the economy — close to pre-recession levels.
The consensus is almost always wrong in some respect; the question is in which respects the economy will surprise us. A lot rides on how much hiring employers do. Here are three of the other big variables.
Business investment is primed to rebound. Will it?
The pullback from consumers spooked by an economic downturn spurred an even sharper withdrawal by businesses. Capital spending tumbled during the recession more than it had at any time since the Great Depression. That means it has plenty of room to recover, if businesses can grow more confident.
Business balance sheets overall look promising. Corporate profits are up, the cost of capital is down and productivity is strong.
Firms have plenty of funds to finance investments, from machinery to software. The corporate financing gap, a reflection of how much firms must raise externally, hit a negative $189 billion in the third quarter from a negative $153 billion in the April-June period, according to Federal Reserve data. A negative financing gap means companies have the funds in house to support their capital expenditures.
“Unlike the household sector, the corporate sector is in excellent fiscal condition,” says Robert Barbera, chief economist at Investment Technology Group Inc., a brokerage and financial technology firm. Businesses are “wildly generating more money than they’re using to invest.”
A sustained rebound in capital expenditures can’t occur without a modest improvement in consumer spending. But pent-up demand by businesses, after slashing expenditures sharply in the past year, could prove critical in giving the economy the velocity it needs to recover.
Economists are on counting on some improvement in capital spending. On this front, we could see an upside surprise in 2010.
Will housing heal?
Trouble throughout the housing sector clearly is abating. But homeowners, lenders and builders have a long way to go before regaining confidence.
Sharp home-price declines can lead consumers to spend less and banks, hit by loan losses, to lend less. While the worst of the price drops appear to be over, home values nationwide are expected to show tiny gains — if any — throughout 2010.
The biggest reason: the troubling spike in home foreclosures is nowhere near its end. At the end of the third quarter, 4.5% of loans were in the foreclosure process, up from 3% a year earlier, according to the Mortgage Bankers Association. On top of that, 9.6% of all loans had at least one past-due payment. Until the unemployment rate recovers substantially, improvement will be elusive.
All of that means more homes coming on the market, pushing values lower. “There still is a huge, huge excess of homes,” says Jim O’Sullivan, chief economist at MF Global. Due to better home affordability “you’re going to eat into that glut over time, but nonetheless there’s still a huge excess.”
Much of the recent improvement in sales is due to low mortgage rates, spurred by the Federal Reserve’s purchase of mortgage securities, and a federal tax credit for home buyers. Both are set to expire by the middle of next year. When they do, sales activity will take a hit.
One area of housing could show some hope. Residential investment fell so sharply during the economic downturn that it has little room to decline further.
Sales of new homes in November stood 74% below the July 2005 peak and are unlikely to reach that level again for many years. But inventories have been whittled down to the lowest level since 1971, so construction is likely to rise and contribute to overall growth in the economy.
After two years of turmoil, forecasters’ consensus view is for minor improvement in housing in 2010. For home prices, the risk is clearly to the downside given mounting foreclosures. But home construction, starting from its depressed levels, has a good shot at being a positive surprise for 2010.
Will the economy withstand loss of public-sector support?
The government put the U.S. economy on an artificial heart pump for much of 2009. If the life support comes off as scheduled in 2010, we can expect a few bruising setbacks.
The $787 billion mix of tax cuts and spending deserves credit for helping to spur growth in the economy — and improve confidence — in the second half of this year. Goldman Sachs economists expect fiscal stimulus will continue to boost annualized growth by two percentage points in the first half of 2010. In the second half, the boost is gone.
Outside the labor market, the biggest question mark hanging over the economy is how consumers and businesses respond when the government support fades. Many consumers picked up lower-priced houses and cars in 2009 thanks to government aid. Businesses found construction contracts and cheaper loans thanks to taxpayer support.
Congress and the White House, in an election year plagued by high unemployment, are planning more programs to boost hiring by businesses, support local governments and increase infrastructure spending.
But they’ll face the risk that doing more will create other problems through a rising deficit. “You are getting to the point now where the worries about fiscal sustainability really are intensifying,” J.P. Morgan Chase economist Michael Feroli says. “Slowing down the drag does come with a cost.”
The story of 2010 could be how the economy fared when the government spigots turned off. The consensus expects the private sector to pick up the baton, but the downside risks to the economy as federal aid fades are substantial.