From the July 01, 2010 issue of Futures Magazine • Subscribe!

Economic recovery: Are we there yet?

Leahey says that while the direct linkages of the United States and Europe through trade are relatively small, the indirect linkages to the credit markets are big. “If the money markets freeze up, that could give you a Lehman-style blowout and the economy could go back into the tubes. [Europe needs] a stronger growth picture. Germany has to be willing to grow faster. How is Portugal going to tighten its belt and avoid a deep downturn without Germany growing faster and buying its stuff? If Germany wants to grow slowly, that may end up killing the euro. Not because they’re not willing to put up the money, but because they’re not willing to put up the growth,” he says.

Kimbarovsky doesn’t think Europe’s impact on economic recovery will be quite as significant. “[The U.S.] has such an import-oriented economy that that’s going to drive [recovery] more so than what’s happening in Europe,” he says. “The big player in the next 10 years will be China. They have a lot of reserves.”

Floyd says that if the Chinese economy does slow down, it could further dampen the hopes of a recovery. “The Australian dollar has [experienced weakness] and that could be a result of China. Commodity prices have come up. Those are not signs of a robust economic recovery by any stretch,” he adds.

But for now, the economic picture in China looks bright. In its April meeting minutes, the FOMC noted that China’s real gross domestic product (GDP) increased at a higher than expected annual rate in the first quarter as economic recovery remained broad based with continued growth in industrial production, investment and domestic demand.

Hardly working

Back in the United States, unemployment continues to weigh on the overall economy, with the jobless rate sitting at 9.7% in the May report. The FOMC at its April meeting predicted a 9.1 to 9.5% rate for the fourth quarter of 2010, declining to 6.6 to 7.5% by the end of 2012 (see “Making it work”).

Chart

Most analysts agree that although jobs recovery is coming, it won’t be swift by any means.

“If the economy doesn’t pick up more robustly than the 2.5% to 3.5% growth rate that we’re currently expecting, then the labor market won’t have much chance either,” Rupert says. “Unemployment rates [won’t] really come down until the middle of the decade.”

Garner says the jobs outlook will improve, but not overnight. “[After layoffs during the recession], firms have found that they can conduct business with a lot less people than they thought they could.”

Leahey offers a good news-bad news scenario on the jobs market. “We’re generating a number of private sector jobs. The gains are quite impressive and broad-based. Unfortunately, in the last 20 years, we’ve had slower job recoveries and in this case we have a deep hole of eight million workers who lost their jobs. Even if you assume 150,000 job gains per month for the next five years, you wouldn’t get the level of employment back to where it was in 2007 until 2015,” he says.

Kimbarovsky provides a brighter outlook. “When you’ve reached equilibrium on net firings, you’re only looking in one direction and that’s up,” he says.

Although recovery will be slow, the economy appears to be headed in the right direction. The FOMC in its April meeting raised expectations for GDP growth in the U.S. to 3.2% to 3.7%, up from its January predictions.

Caution required

In this environment of sluggish economic recovery and uncertainty, traders need to be cautious. Kimbarovsky says the current environment makes it difficult to trade based on fundamentals. “You have an overwhelming political cover for what’s essentially 40-50 years of excess. It doesn’t resolve itself in six months or a year,” he says.

Everyone knows that interest rates eventually must rise, but the recent credit crisis has been unique, so there is no easy roadmap to follow for fixed income markets as we slowly move from recession to recovery.

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