April 1, 20102010 is off to a strong start, building on the accelerating recovery that began in 2009. In 2009’s fourth quarter gross domestic product (GDP) posted a healthy 6% growth rate, driven by strong government outlays, increased business activity—mainly, rebuilding very low inventory levels—and a nascent recovery in consumer spending. First Quarter Economic Review The Federal Reserve (the Fed), our nation’s central bank, maintained short-term rates at near zero, but began a process of unwinding some emergency programs that have pumped liquidity into the financial system. Meanwhile, corporate profits remained strong overall, as business activity improved and, as a byproduct of cost cutting during the recession, productivity soared. In addition, we saw the mounting effects of the government’s ongoing economic stimulus plan, which significantly increased federal spending, the federal deficit and U.S. Treasury borrowing. Long-term interest rates, which jumped recently, still remained in a narrow range, even in the face of record-setting Treasury bond issuance. As a result, the “Great Recovery” remained on track, buoyed by government spending to stimulate growth and job creation. However, a difficult task lies ahead for the Fed: it must balance the powerful deflationary effects of private debt reduction against the risk of over-stimulating the economy and its potential consequence, rising inflation. Looking Ahead We expect the economy to move toward greater normalcy in the months ahead, albeit at a fairly moderate pace. But the sheer size of the credit crisis and the heft of the government’s response, in our minds, combine to dramatically increase the range of possible outcomes. If the economy continues to recover steadily, business and investor confidence should improve, increasing risk appetites and thereby producing more sustainable growth. In time, when productivity gains from downsizing fade and inventory reduction bottoms, businesses may begin hiring in earnest. Unfortunately, we believe jobs growth will probably lag the levels seen after recent, much shallower recessions. Nevertheless, any job growth should bolster consumer confidence, along with a noticeable recovery on the asset side of consumer balance sheets. The combination of stabilizing home prices and recovering 401(k) balances due to a strong stock market rally should begin to produce a “wealth effect,” leading to more vigorous consumer spending than we have seen thus far. Today, we are beginning to see more self-sustaining momentum in the economy —a welcome change from the downward spiral of the 2008 credit crisis. Fed’s Dilemma Approaches The next few quarters should see the Fed reversing its emergency monetary policy that has been characterized by historically low rates and a deluge of liquidity. While it is likely to leave the Fed Funds rate near zero until late 2010 or early 2011, we expect it to allow emergency liquidity programs to expire as markets return to normal. Low rates serve to keep the yield curve steep and thereby benefit bank profitability and capital. Healthier banks are better able to increase lending, which in turn can encourage business expansion, especially in small- and medium-size enterprises that tend to drive employment gains. At some point, the Fed will face a very difficult decision, as it seeks to encourage economic recovery while avoiding a bout of runaway inflation. Tactically, the Fed seems likely to err on the side of leaving rates low for too long a period—mainly, for political reasons. Obviously, the optics of raising interest rates while unemployment remains high are very poor. At the same time, we believe inflation should remain in check for the time being as the private sector continues to delever by selling assets and reducing debt. Much like in the 1970s, it could conceivably take years before the seeds of inflation being sewn today actually take root. While we are reasonably confident in the economic recovery for 2010, assessing the prospects for the economy and financial markets farther ahead looks quite challenging. We are likely to face a daunting list of variables, including Fed short-term rate increases, rising taxes, the funding of new entitlements, including mandated health insurance, persistent Federal and state budget deficits, the winding-down of government-stimulus programs, the ramp-up of government regulation and finally, the growing risk of future inflation. Without question, that is quite a list, but we believe it has never been more important to be aware of the risks and prepared for the future. The views expressed in this report are those of Eaton Vance and are current only through the date stated at the top of this page. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investÂment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. Before investing, prospective investors should consider carefully the Fund’s investment objective, risks, charges and expenses. The Fund’s prospectus or summary prospectus, if available, contains this and other information about the Fund and is available through your financial advisor. Read it carefully before you invest or send money. Why Eaton Vance? Eaton Vance provides investment solutions to individuals and institutions, guided by the principles of fiduciary responsibility and our deep experience. Since its founding in 1924, Eaton Vance has held fast to Charles Eaton’s belief that “a well-rounded investment management organization is not engaged in a guessing game with other people’s money. It is doing a highly specialized professional job, endeavoring to apply knowledge, judgment and decisiveness in action.” The Company’s long record of providing exemplary service and attractive returns through a variety of market conditions has made Eaton Vance the investment manager of choice for many of today’s most discerning individual and institutional investors. Not FDIC Insured • Not Bank Guaranteed • May Lose Value (c) Eaton Vance Investment Managers
|
Most Popular Articles
