James Pethokoukis

Politics and policy from inside Washington

More 2010 forecasts

Dec 29, 2009 18:12 UTC

Here is an interesting one from MF Global fully adopting the New Normal mantra:

On debt:

The IMF predicts that in 2010 the average government gross debt as a percentage GDP for the 7 major advanced economies will be 109% and 113% in 2011. It was only 84% in 2007 and 77% in 2000. Following the global down turn in the 1990s, average gross debt as a percentage of GDP increased from 58% in 1990 to 80% by 1996. History suggests that post recession, the reduction in government spending is rarely equivalent to the increase catalyzed by the retrenchment in the private sector. Given the breadth and depth of this past recession and lingering risks in the system, the pull-back in government spending will be even less. Moreover, the initiatives of the US government are costly and the passage of the healthcare bill will only increase the financing needs. As the global recovery takes hold it will be increasingly difficult for governments to attract interest in their securities as their yield reside at historic lows. Outside of valuation, fears over defaults will also keep the market wary of government debt. Widening sovereign CDS spreads underscore the market’s already elevated concern. While a widespread tidal wave of defaults is unlikely, poor auction demand in the wake of the recovery and in the face of heavy financing needs will increase trepidation about its possibility.

On unemployment:

2010 will be characterized by a jobless recovery. MFGR sees the unemployment rate peaking in 2010 at 10.5% and closing the year between 9.5% and 10%.  … On the US front, the outlook for taxes is murky and the healthcare initiative which will likely force all employers to provide care or pay a penalty will discourage the expansion of the labour force. Though the Obama administration is extending the capital gains holiday for small businesses, employers need to feel confident that their profit margin will not erode in the future due to tax increases in order to genuinely contribute to job growth. Moreover, budget shortfalls at the state and local government level will cap government hiring. Globally speaking, there has been a significant increase in structural employment that is now part of the new normal. The collapse of the financial markets has led to a permanent shrinkage of the financial industry and the impendingregulation will make financial innovation, a factor that does lead to job growth, very difficult. The manufacturing industry faces the same problem. Globalization will lead to the removal of manufacturing jobs in advance economies and cause a shortage of skilled labour forcing many to look to build other skill sets.

On taxes:

The tax burden in the U.S. and Europe is likely to increase. The on going deterioration in public finances, at both the state and government levels, will put upward pressure on taxes in the U.S. Moreover, the Bush tax cut is expected to sunset in 2011. There is some feeling that Congress will vote to extend lower tax rates, but this is likely to come for earners making less than $250,000. Somehow, the $250,000 income level has become the definition of rich in America. Capital gain and dividend taxes are also likely to rise for high income workers and risk leading to a re-pricing downward of assets. Furthermore, the healthcare bill contains another tax hike on high income workers, and will likely lead to higher healthcare insurance fees. The healthcare mandate will act like a tax by raising the cost of healthcare for many workers. At the state level, California, Illinois, and New Jersey face massive fiscal strain and politicians are reluctant to address pension, healthcare, and wage costs in order to boost the productivity of government workers. Unions are a strong constituent and politicians do not want to upset a large voting block.

On US politics:

Passage of the Democratic healthcare plan will mark an apex in U.S. liberalism. Government policy will shift toward the center into midterm elections. Polling data highlights the falling popularity of the Democratically controlled Congress and President Obama. The NBC/Wall Street Journal poll displayed the Congressional disapproval rating at an elevated 68% in mid December. At the same time, data produced by Rasmussen has shown President Obama’s approval index falling from a peak of +30 on January 22, 2009 to a post Christmas reading of -12. The champion legislation of the Democratic Party, healthcare, is also finding limited support. The recently passed Senate healthcare bill has displayed a high level of public disapproval highlighting anger over the intervention of government into healthcare. Rasmussen’s polling numbers on healthcare show most voters oppose the healthcare plan and just 25% believe they will be better off. The likely and soon to be passed healthcare bill has been passed on a totally partisan basis in the face of growing opposition to government policy. Recent Democratic losses of governorships in New Jersey and Virginia spotlight the tilt of support by the public toward the party out of power. Furthermore, Alabama Congressman Parker Griffith recently switched to the Republican Party from the Democratic Party. The “Blue Dog” feared losing his seat in 2010. The high level of discontent with politicians is occurring in the back drop of “Tea Parties” and grass root movements to stop the reach of government given excessive spending and a high tax burden. Unemployment is still elevated, and income growth is slow. The public is angry over the impact of a stimulus plan which may have saved the financial system from melt down, but did little to improve standards of living. Democrat leaders in Congress have fought for their agenda at all costs, and will now try to reverse their tactics in order to improve their public image. Politicians, at the core, are survivalists and thus policy is likely to move toward the center to attract discontented voters. The Democratic leadership is aware that history is not on their side for mid term election victories and power loss can be expected. For example, during the 1994 mid term election, President Clinton and the Democrats lost 9 seats in the Senate and 54 in the House. In 1946, President Truman and the Democrats lost 12 Senate seats and 55 House seats. Going back further, FDR and the Democrats picked up 10 Senate seats and 9 House seats in 1934, but suffered major losses in 1938 and 1942 with 7 House seats (6 Senate seats) and 45 House seats (9 Senate seats) lost in 1938 and 1942 respectively

19 risks for 2010

Dec 29, 2009 15:43 UTC

Courtesy of the Naked Capitalism blog:

1. The Bulk of the Option Arm resets trigger in 2010-2011 – “The reality is that these loans were never meant to survive the reset. Unless an alternative is created, the human pain and loss will be massive.” Institutional Risk Analyst Chris Whalen
2. The Black Holes at FNM and FRE and other GSEs continue to grow
3. Bank hoarding in 2009, with no end in sight until those option arm resets trigger and all toxic assets have been brought back onto their balance sheets by 2013
4. State and local governments defaulting on financial obligations. To meet financial obligations, austerity measures will be required, social obligations will suffer, meaning more unemployment and less teachers, firemen, and policemen. This burden will be another source of drag on the U.S. economy.
5. Credibility of the Fed and U.S. Treasury and White House Administration will be on the forefront on Investors minds in 2010 and beyond. If their credibility suffers, there will be negative ramifications in the financial markets
6. Stock Market Rescue Operations like the one that got underway in March 2009 tend to last roughly two years, and are followed by bear market resumptions. My models indicate the 2009 bear market rally may end sometime in 2H 2010 followed by a resumption of the secular bear market into 2012-2013.
7. My models also indicate the 2009 bear market rally in the Dow Jones may peak at 11,750-to 12,000, near the bull market crest in 2000. That leaves maybe 12% further upside in 2010 and implies that most of the gains from this bear market rally are already in place. As David Rosenberg pointed out throughout 2009, this is a rally for investors to ‘rent.’ What reallocations can they make as and when the rally ends?
8. Advanced Economies in America and Europe all face Pension liability nightmares with shrinking workforces to support the retiring population, recent examples are GM and YRC pension nightmares. Are taxpayers going to be obligated to fund all private and public pensions of bankrupt companies and state governments?
9. Risk Aversion, saving more versus spending more will be a drag on the economy
10. U.S. government mandate requiring 30 million uninsured Americans to buy health insurance will curb consumer spending and act as a tax on the economy. It will also curb hiring plans amongst U.S. employers further prolonging Americans sidelined from employment opportunities and exacerbating the unemployment rate issues.
11. Will the kindness of foreigners continue to fund the U.S. deficit spending? Eric Sprott and David Franklin noted in their December 2009 missive titled “Is it all just a Ponzi Scheme?” that the “household sector” bought $528 billion of the $1.88 trillion of U.S. debt that was issued to them. This sector only bought $15 billion of treasuries in 2008, where would this group find the wherewithal to buy 35 times more than then bought in the previous year. Sprott concludes that makes no sense with accelerating unemployment and foreclosures, so the household sector must be a “phantom. They don’t exist. They merely serve to balance the ledger in the Federal Reserve’s Flow of Funds report.”

Global Risks and Uncertainties
12. Sovereign Risks of Default are increasing as is their fiscal credibility in countries with large debts
13. Asymmetries within the EMU could precipitate a possible breakup of the EMU. The solidification of the countries in the EMU may break-up like ice sheets in the Artic tundra as the global financial meltdown puts further stress on the EMU. Incentives to remain in the EMU, for many EU countries it might be better to leave the EMU than stick around for its constraints and austerity measures
14. The One-size fits-all monetary policy in the EMU may be derailed by this crisis
15. Germany may not want to subsidize weaker countries in the EMU if their exports to those weaker euro countries are falling off a cliff as the crisis rolls on
16. The ECB may not be able to accept sovereign collateral and assets from countries in the EMU that have a negative credit outlook and are later hit with further downgrades. That could have spillover effects into the banks-at-large, including the ones the U.S. government sought so frantically to save.
17. The PIIGS (Portugal, Ireland, Italy, Greece, and Spain) debt ratios are all expected to exceed the 3% GDP 1992 Maastricht Treaty requirement.
18. PIIGs negative 2009 GDP resulting from global export decline leaves them with little incentive to stay strapped to an expensive Euro.
19. Italy is expected to be the first country that will first kiss the EMU good riddance. Greece and Spain might not be far behind as a domino-effect takes hold.


Agreed. These guys are WAY too bearish. We definitely need a dose of Larry Kudlow’s optimism.

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