Economic Review 2011 – 4th Quarter

Valuations Between January 1, 2012 and March 31, 2012

In his October 4, 2011, speech to the Joint Economic Committee of the U.S. Congress, Ben Bernanke, Chairman of the United States Federal Reserve, noted that consumer behavior has both reflected and contributed to the slow pace of the economic recovery. The high unemployment rate, a depressed housing sector, and an ongoing deleveraging process weigh on the ability and confidence of consumers to spend. Recently revised economic data shows the 2008-2009 recession was deeper and the subsequent recovery is weaker than previously thought. Additionally, in the first half of 2011 GDP was impacted by the transitory effects of the supply-chain disruptions caused by the Japanese earthquake and tsunami in March 2011, an increase in commodity prices, and turmoil in the Middle East. Chairman Bernanke did note the positive impact of recent levels of manufacturing, exports, and business investment. In the third quarter of 2011 real GDP first exceeded the level of the fourth quarter of 2007, the start of the latest recession.

The U.S. Bureau of Economic Analysis (BEA) estimates that real gross domestic product (GDP) increased at an annual rate of 1.8 percent in the third quarter of 2011. Quarterly GDP data1 for the preceding ten years is shown in the following figure.

The Federal Open Market Committee of the Federal Reserve meets periodically to assess current economic conditions and determine appropriate financial policies to fulfill its dual mandate of fostering maximum employment and price stability. At its December 13, 2011, meeting the Committee kept the target federal funds rate at zero to 0.25 percent and cited various factors for maintaining monetary policy that is very loose by historical standards, including slow economic growth, a depressed housing sector, and continuing weakness in overall labor market conditions. The Committee is in the process of extending the average duration of the Treasury bonds and other securities held on its balance sheet. By June 2012 the Committee expects to conclude these purchases of $400 billion in longer-term securities and corresponding sales of shorter-term securities to further reduce long-term interest rates. The Committee also expects that low rates of resource utilization and a subdued medium term inflation outlook will warrant keeping the federal funds rate at its current level until mid-2013. Ten years of historical interest rate data2 for the Federal Funds Rate, 10-Year U.S. Treasury bonds, and Moody’s Corporate Baa-rated bonds are shown in the following figure.

The unemployment rate in the United States as of August 2011 was 8.6 percent on a seasonally adjusted basis,3 which places severe strain on the economy as consumers are unable or unwilling to spend. The Congressional Budget Office’s (CBO) August 2011 report stated that, “the economic recovery will continue, but real GDP will stay below the economy’s potential until 2017.”4 The CBO estimates that real GDP will grow 2.3 percent in 2011 and 2.7 percent in 2012, down from CBO estimates in January 2011 of 3.1 percent and 2.8 percent, respectively. The CBO cited expected strong growth in business investment, gains in net exports, and the beginning of a recovery in new-home construction as factors facilitating GDP growth. In November, the Federal Reserve lowered its projected 2012 GDP growth to a range of 2.5 percent to 2.9 percent from anticipated growth of 3.3 percent to 3.7 percent as of June.

GDP growth rates are expected to increase as the economy continues to recover from the severe recession that began in December 2007. However, as states struggle to close budget deficits, downward pressure will be applied to the economy. Additionally, the winding down of the stimulative elements of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 will cause fiscal tightening. Inflation, as measured by the Core Consumer Price Index, which excludes the effects of food and oil, is forecast by the CBO to be 1.3 percent in 2012, eventually increasing to an average of 2.2 percent per year in the 2017 to 2021 period.

1 Source: U.S. Bureau of Economic Analysis. GDP percent change based on chained 2005 dollars.
2 Federal Reserve Statistical Release H.15 (519) Selected Interest Rates.
3 U.S. Bureau of Labor Statistics.
4 U.S. Congressional Budget Office. “The Budget and Economic Outlook: An Update.” August 2011.