No Double Dip, but Not Much Growth

06/30/2009 12:00 pm EST

Focus: MARKETS

Knight Kiplinger

Editor-in-Chief, The Kiplinger Letter, Kiplinger's Personal Finance, and Kiplinger.com

Knight Kiplinger, editor-in-chief of The Kiplinger Letter, says the economy should avoid the worst, but at best we’re likely to have a subpar recovery.

What are the odds of a double-dip recession? Relatively low, though we can’t rule it out.

The economic pluses outweigh the minuses. Consumers are now showing a willingness to spend, despite high debt levels and rising foreclosure rates. Their long-term history suggests they’ll keep it up. Confidence, rebounding smartly, will keep improving, helped by a 25% drop in gas prices after mid-July.

The biggest economic woes are behind us. Some banks are raising capital and paying back taxpayers as credit markets recover. Lending remains limited, but is beginning to revive. Painful decisions have been made, and the [automobile] industry can now start to reinvent itself.

Firms have cut [inventories] to the bone. As consumer demand picks up, so will production. That’ll boost gross domestic product and—eventually—employment. Home sales [are] climbing, albeit slowly, and a bottom in prices is six to nine months away in the hardest hit markets. Housing will add a point to GDP growth in 2010, after subtracting a point in each of the previous three years.

The Federal Reserve will raise interest rates. The tricky question is when. Timing the move will be critical. If Fed policymakers act too fast, the recovery could be snuffed out. If they wait too long, bond traders will push rates up, making loans unattractive for home buyers and businesses trying to regain footing. This could halt the fragile expansion, which depends on affordable credit. Our judgment: a rate hike some time in the second half of 2010.

In the meantime, the Fed’s words will matter as much as its actions. [Chairman] Ben Bernanke and his colleagues need to keep bond investors reassured over the next several months that they’ll stay ahead of the curve on curbing inflation. Even without real pressure on prices or on wages, bond traders worry about the trillions of dollars in Treasuries needed to fund soaring deficits.

Business investment will shrink in 2010’s first half. Companies will move cautiously, delaying major projects until they see stronger GDP growth. That may take a while. Commercial real estate’s difficulties started last year, but the dive has gotten steeper. There’s a ripple effect, creating problems for many. As more leases expire, renters will demand big discounts to stay where they are. And new construction will stay mired in the doldrums.

Unemployment won’t start coming down until the second half of 2010, after peaking at well over 10%. That won’t feel like a recovery to many workers.

[So], the recovery will be lethargic—subpar growth of only about 2% in 2010 and a bit more in 2011, well below growth after other deep recessions since the 1940s. Plus, any financial or geopolitical shock to the system could easily derail a recovery. Even without a shock, [we’ll have] a fragile economy, grappling with several recession hangovers, making it a challenge to build momentum for growth.

Subscribe to The Kiplinger Letter here…

Related Articles on MARKETS