Quantcast
Economic Outlook

Economists: More Growth Ahead, Unclear for Jobs

WASHINGTON — Economists have raised their estimates for economic growth in 2011, but they have mixed views on whether the unemployment rate will come down. While an improved economy should bode well for state and local governments, most will still face severe budget problems, particularly with the loss of federal stimulus funds.

Economists have become more optimistic about the economy, with the Federal Reserve buying Treasuries through June 2011 and the new tax law extending Bush-era tax cuts for two years.

Earlier this month, economists at JPMorgan Chase revised their real gross domestic product growth estimate to 3.5% for 2011, on a fourth-quarter to fourth-quarter basis, from 3.0% previously. Their estimate for consumer spending was revised up to 3.5% from 2.6%.

Economists at Goldman, Sachs & Co. are forecasting real GDP growth of 3.4% in 2011 from 2.7% previously.

"We're fairly bullish on the economy," said Scott Minerd, chief investment officer at Guggenheim Partners LLC. The combination of the Fed's monetary policy plus the tax cut extension "only reinforces the view that next year's growth will be stronger," he said.

A poll of economists conducted by the Securities Industry and Financial Markets Association estimated real GDP would increase at a 2.6% annual rate in 2011, according to the median estimate. The 21 economists also forecast a 9.2% average unemployment rate for 2011.

The SIFMA estimates are more pessimistic than the Federal Reserve's forecast for 2011, which was released in November. The Fed forecasted 3.0% to 3.6% real GDP growth for 2011 and an unemployment rate between 8.9% and 9.1%.

If 2011's GDP growth comes in less than forecast, then the unemployment rate will likely remain high, some sources said.

Kevin Schultze, managing director at Stone & Youngberg LLC, contends that next year's GDP growth will "not [be] sufficient to make an appreciable dent in the 9.8% unemployment rate."

For state and local governments, the persistently high unemployment rate means "the ice will continue to get thinner and thinner," he said. Economists differ on what will happen with employment. Some said economic growth in 2011 will not be strong enough to rein in the unemployment rate, which stands at 9.8%. Others said they see factors conducive to employment growth next year, such as an increase in temporary hires by companies and stronger business productivity.

"All the pieces are there for a better employment market," said Robert DiClemente, senior U.S. economist at Citi.

Stagnant job growth in 2010 stemmed partly from businesses' "post-financial stress syndrome," DiClemente said. The recession's fallout "makes businesses more skittish about the outlook," he said. "I don't think we should underestimate what damage has been done to the entrepreneurial spirit."

But a key concern among economists is the extent to which there will be long-term unemployment — workers without jobs for a year or more, sources said.

Many of these long-term unemployed workers come from the construction and manufacturing sectors and "will be left behind," as the recovery continues, said Lakshman Achuthan, managing director of the Economic Cycle Research Institute.

"There's ultimately not a job for them," he said. "Most will never get their jobs back."

Low interest rates and unemployment benefits will be of little help to these unemployed workers. Ultimately the cost of the long-term unemployment problem will fall on state and local governments, he said.

BABS

But even if economic recovery continues at a good clip and unemployment drops, state and local governments will still face budgetary challenges, particularly with the loss of stimulus programs and funds.

Muni market strategists said the Dec. 31 expiration of the popular Build America Bond program will stress the muni market.

Through Dec. 23, issuers had sold $$15.3 billion of BABs during the month and $181.4 billion since the start of the program in 2009, according to Thomson Reuters.

The expiration of the BAB program could affect long-term muni yields, market sources said.

"The strength of the [BAB] program was that it attracted new sources of demand, especially in the long end" of the municipal yield curve, said Michael Decker, managing director and co-head of the municipal securities division at SIFMA. Traditionally, "there has been a relative scarcity of buyers for long-term bonds," he said. "BABs filled that hole."

The post-BAB environment means "there's going to be a lot more volatility," said George Friedlander, the head municipal strategist at Citi.

"We look a lot more like the old tax-exempt market where supply clogs [can] move in an outsized way until the market is able to clear," he said. "BABs took that away, and it's back."

For issuers, the loss of BABs means "some projects won't get financed because of [higher borrowing] costs," Decker said.

Along with the BAB program, federal aid to state and local governments is expiring at the end of year. The American Recovery and Reinvestment Act of 2009 allocated federal funds to states for Medicaid and education spending.

BOND DEFAULTS

As those funds dry up, investors could see more bond defaults in 2011, sources said, though they all agreed that media reports calling for a systemic municipal bond meltdown in 2011 are overblown.

Robert Kurtter, a managing director at Moody's Investors Service, said the rating agency expects the number of municipal bond defaults "will go up" in 2011, but will still be lower than in the corporate market. However, even "a handful" of defaults "creates huge alarms across the muni market," he acknowledged.

Sources said a liquidity crisis may be a factor in spurring a municipality into default.

"Someone will have a funding crisis," Minerd said, and the most likely threat of a default could come as a liquidity crisis. An issuer that has a budget deficit and needs money quickly might not be able to sell bonds to the market, or the issuer could face a "crisis of maturity," in which it cannot roll short-term bonds over into long-term bonds, he said.

Friedlander said: "The budgetary pressures will be there [and], in our view, will mean a handful of additional defaults."

But Goldman Sachs economist Andrew Tilton said in a Dec. 17 release on the economy that any prolonged illiquidity in the municipal market "would surely prompt intervention by fiscal authorities or the Fed."

There will not be "a significant increase in the number of municipal defaults or bankruptcies versus historical experience in the near term," Janney Montgomery Scott LLC analysts said in a Dec. 20 release on the economy that noted there have been few defaults in municipal securities regarded as "safe," such as general obligation bonds.

Bankruptcy filings under Chapter 9 of the United States Bankruptcy Code, which allows municipalities to restructure their debt, are even more unlikely, sources said. There were only five Chapter 9 filings in 2010 and 10 in 2009, according to data from James Spiotto, an attorney with Chapman and Cutler LLP.

Bond defaults won't necessarily lead to more Chapter 9 filings, he said.

"The traditional history has been that municipalities work through" their defaults without resorting to Chapter 9, he said.

INTEREST RATES

The December run-up in municipal yields is likely to be short-lived, sources said. Once the supply glut, resulting from the expiration of the BAB program has cleared, munis are likely to appreciate relative to Treasuries, sources said.

Municipal bonds have "a lot of room for upside appreciation," Minerd said. He said investors risk "missing the opportunity" to buy munis while they are cheap.

"It's always difficult to buy when the market is frightening," he said.

The SIFMA economists forecasted the 10-year Treasury note will be 2.8% in June 2011 and 3.3% by the end of 2011, according to the median estimate.

"As long as we can avoid another financial shock, cyclical forces gradually are strengthening and that's tending to be reflected in raising bond yields," DiClemente said.

Sources said the Fed's plan to purchase $600 billion of Treasuries through June 2011 will keep rates low and is likely to steepen the yield curve.

The "absolute interest rate environment will remain benign," said Dominick Mondi, senior managing director at Mesirow Financial. Investors next year "will have a pretty accommodative Fed keeping rates, especially on the short end, business friendly," he said.

The 10-year triple-A municipal yield on Dec. 15 jumped to 3.27%, the highest level of the year. The 10-year Treasury reached a high for the month of 3.50%, also on Dec. 15.

Issuers moved several deals into December that they might have scheduled for January and February, sources said. This means the first two months of 2011 could be "eerily quiet," Friedlander said. The drop in supply could be "dramatic" next year, and that will help the market work off the December supply glut, he said.

Schultze said he does not expect to see the GDP growth next year that the Treasury market has priced in already. "We could get a slight pullback" as the market readjusts, he said.

For munis, it might take "a full quarter" for municipal yields to come back down from the December highs, he said.

INFLATION

The expectation on inflation remains the same in 2011 as it was for this year — it poses a limited risk to muni investors. While the Fed's efforts to ward off deflation have been successful, sources said inflation will not threaten bond investors next year.

"The Fed is clearly pursuing a policy of reflation," Minerd said. But for now, "nothing in the inflation pipeline indicates that the Fed is currently succeeding at raising prices."

Core personal consumption expenditures, the Fed's preferred inflation gauge, increased 0.8% in November, a record low, the Commerce Department reported on Dec. 23.

The monetary policy has not changed people's mindset on economic growth. While rates are accommodative, "a lot of that punch is not going to make its way through" as people remain cautious about the economy, DiClemente said.

"I think it's safe to say we're still closing off the last of the deflation threat and we have not put higher inflation in play," DiClemente said.

Still, it is dangerous to bet against the Fed, Minerd said. Ultimately, the central bank "will succeed" in reflating the economy, he said.

Upcoming Events

Already a subscriber? Log in here
Please note you must now log in with your email address and password.