Economy: Updating The 2010 Forecast

Georgia’s recovery will be slow and bumpy, but sustained. Fortunately, the period of heavy job losses is over.

Both the U.S. and Georgia economies are performing slightly – but not dramatically – better than expected, but I’m still concerned about the stability of the credit markets and the housing markets.

Domestically, I worry most about an increased number of strategic defaults on home mortgages. We see households able to make their mortgage payments opt to walk away, and some 23 percent of homeowners are underwater on their mortgages.

I am especially concerned about people’s willingness to continue making mortgage payments on high-end homes in markets where home prices have fallen dramatically. If too many people walk away, home prices will continue to decline, aborting the ongoing recovery of the single-family housing market. This would further test the stability of our fragile financial markets.

The good news is that the prices of most existing homes have not declined dramatically in Georgia. So strategic defaults should be less of an issue here.

I am sticking with my basic call that the economic recovery will be sustained, and that it will be a sub-par recovery. Going forward, both the upside and downside risks appear to be evenly balanced, but I do expect that growth will proceed more slowly in the second half of 2010 than it did in the first half.

On a positive note, in the second half of 2010, both the quality and the sustainability of growth will improve. An increasing proportion of the gains will come from the private sector and a decreasing proportion will come from the public sector.

The European financial crisis makes it less likely that the Federal Reserve will increase the federal funds rate target as much as I had expected. I now believe the funds rate target will rise from 0.25 percent to only 0.50 percent in 2010 instead of the expected 1 percent.

Still, I suspect that the European financial crisis only shifted the rate hikes forward by one quarter. So, by late in the first quarter of 2011, the Federal funds rate target should be 1 percent, perhaps slightly higher. The window for “cheap” money will remain open at least one quarter longer than expected, but it will still be difficult to qualify for the loan.

Between now and the end of the year, the biggest potential game changer will be the performance of the financial markets: Will credit become easier or harder to obtain? I am betting that credit conditions will ease.

So, here is the forecast: U.S. GDP will expand by 3 percent in 2010 and by 2.5 percent in 2011. This will be the most subdued recovery in consumer spending since WWII.

It will take about six quarters for U.S. GDP to surpass its previous peak ­– that will be late 2010 – and it will take at least three additional years before the labor market replaces the 8.4 million jobs lost. Only then will the U.S. economy be fully healed.

Georgia’s recovery will be slow and bumpy, but sustained. The state GDP should increase by 1.9 percent, a lot better than the 4.2 percent decline estimated for 2009.

Georgia’s economy will continue to suffer from heavy exposure to the real estate downturn, the epicenter of this recession. Our economy was geared towards new residential and nonresidential development, and Georgia had a very high concentration of manufacturing industries closely allied to construction, such as lumber and wood products, building materials, and floor coverings. Additionally, Georgia’s over-dependence on development meant that the financial crisis did much more damage to our banks than to the nation’s financial sector.

Fortunately, the period of heavy job losses in the private sector is over, but some will persist in state and local government and nonresidential construction.

Georgia will end up losing about 350,000 jobs – 8.3 percent of statewide employment and more than twice as many jobs as we lost in the previous recession. In comparison, the nation has lost 6.1 percent of its jobs. Georgia lost a higher percentage of jobs for the same reasons that our recovery will be slower – the state’s exposure to housing, commercial real estate and related industries.

Until real estate and construction stabilize, sometime in mid-2011, Georgia’s economy will underperform the national economy.