The mild ‘W’ scenario

September 16, 2009

Yardeni sketches it out, though he thinks a “muddling along” is more likely:

1) Actually, the Petering Out scenario could start before yearend. Auto sales were clearly boosted during July by the Cash for Clunkers program. Congress expanded the program by an additional $2bn in August, and auto sales continued to rebound. Auto sales will probably weaken again unless it is renewed. Also, an $8,000 tax credit for first-time homebuyers will expire in November.

2) Furthermore, tax hikes are coming. The good news is that the Obama Administration hasn’t endorsed Charlie Rangel’s proposal to slap a big tax surcharge on high incomes as a way to pay for more government spending on health care. The bad news is that a massive tax increase is coming in 2011 after the Bush tax cuts expire next year. It is conceivable that consumers might cut back their spending in 2010 in anticipation of higher taxes.

3) Another concern is that the government will exit its various rescue programs prematurely. For example, last October, the FDIC provided temporary insurance guaranteeing the new debt of banks. Debt issued under the program is insured in some cases through June 30, 2012, and through December 31, 2012, in others. As of September 4, $304.1bn in debt was outstanding under the program. Ninety-four financial institutions have used it to issue debt.

4) The global economic recovery might also be at risk if Chinese authorities step on the brakes. During August, a few of them indicated that they are not happy to see that too much of bank lending has gone into real estate and stock market speculation. So they are leaning on the banks to lend less for such activities. Indeed, bank loans rose $60bn and $55bn during July and August, down from $181.5bn on average from January-June.

In conclusion, my sense is that a W-shaped economic pattern is widely expected. As the focus of investors extends beyond 2010, there are mounting concerns about the likelihood of the second recovery in this scenario, especially during 2011, if the Bush tax cuts are allowed to expire.

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