The Economic Outlook for 2010 Presented to: Houston Economics Club February 18, 2010 Harvey Rosenblum Executive Vice Pr

1. The Economic Outlook for 2010 Presented to: Houston Economics Club February 18, 2010 Harvey Rosenblum Executive Vice President & Director of Research Jessica Renier Senior Economic Analyst Federal Reserve Bank of Dallas The views expressed in this presentation are strictly those of the authors and do not necessarily reflect the positions of the Federal Reserve Bank of Dallas or of the Federal Reserve System.

2. Economic Model: Recessions Guitar-string theory: Deeper recessions are followed by stronger, more rapid recoveries. - Milton Friedman

3. Economic Model: Financial Crises “The aftermath of deep financial crises shows deep and lasting effects on asset prices, output and employment. Unemployment and house price declines extend out for five and six years. Output declines last two years on average. Even recessions sparked by financial crises do eventually end, albeit almost invariably accompanied by massive increases in government debt.” - Reinhart and Rogoff (Dec. ‘08)

4. Summary Forecasts for 2010 • GDP: 2-3%, more likely close to 3% • Absent the financial crisis: 5-6% • Headline inflation: 3.0% • Core inflation: 1.5% • Unemployment: • 10.4% peak in 2010 Q2 • Sustained employment growth to begin Feb. 2010

5. But This Time is a Combination This recession was… • Most painful since the Depression • Longest, Deep and Wide • Followed 25 years of growth interrupted by two short, mild recessions Bottom Line: • Relative to a generation of experience, this was a truly traumatic event.

6. Behavior Modification Only traumatic events, not hiccups, produce behavior modification.

7. Global Backdrop

8. IMF World Economic Outlook:What a Difference a Year Makes • One Year Ago: 2009 Forecast Source: IMF World Economic Outlook, Oct. ’08/’09

9. IMF World Economic Outlook:What a Difference a Year Makes • One Year Ago: 2009 Forecast • Current: 2010 Forecast Source: IMF World Economic Outlook, Oct. ’08/’09

10. IMF World Economic Outlook:What a Difference a Year Makes • One Year Ago: 2009 Forecast • Current: 2010 Forecast Source: IMF World Economic Outlook, Oct. ’08/’09

11. Purchasing Managers’ Indexes of Manufacturing Activity Source: Institute for Supply Management, Bloomberg

12. G10 Industrial Production(excluding construction) Source: Federal Reserve Board

13. G10 Industrial Production(excluding construction) Source: Federal Reserve Board, UK Office for National Statistics, Statistical Office of the European Communities, Japanese Ministry of Economy, Trade & Industry

14. U.S. Economy

15. Elements of Trauma • High unemployment • Actual deflation • Negative wealth shock • Bursting of multiple bubbles • Synchronized global shocks • Near-demise of banking/financial system

16. Going Forward… Headwinds Tailwinds Emerging Market economies Inventories Labor availability Idle plants Lagged impact of global stimulus Equity market rebound and anticipated profit growth Improving capital markets – lower credit spreads, stronger risk appetite • Credit to households and small businesses • Banking system – capital, CRE losses • Anticipated taxes • Policy uncertainty • Higher energy prices Crosswinds • Monetary policy • Fiscal policy • Regulatory policy

17. Positive Momentum • Growth in temp employment • Declining initial unemployment claims • Declining layoff announcements • Nearly 40% of industries adding workers, vs. 80% of industries cutting employment a year ago • Synchronized global recovery • Capex • Rig count and Semi equipment orders • Industrial production bounce-back

18. GDP and Inflation Real GDP Growth Low-to-Moderate Inflation Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Dallas Fed

19. Why were we so wrong about year-end inflation? • Given fears of deflation at year-end 2008, we thought a 1% deflation over 2009 was the most likely outcome. • We averted that outcome, and that’s a prediction we’re very happy to have been wrong about. • Credit Chairman Bernanke and the FOMC

20. Job Market Simply Awful, But Poised to Turn as Temp Leads Gains Source: Bureau of Labor Statistics

21. Job Market Simply Awful, But Poised to Turn as Temp Leads Gains Benchmark added 930k losses Total jobs lost: 8.4 million Source: Bureau of Labor Statistics

22. Labor Market: A Mixed Bag, But Fixin’to Improve • Level of employment is lowest since Sep. 1999 • Private sector job level similar to Nov. 1998 • Unemployment fell to 9.7% • Likely to rise again once people re-enter labor force • Initial jobless claims have declined, more needed • Wages, hours worked and productivity increasing Bottom Line: Existing workers being pushed harder

23. A Look At Housing

24. Contributions to Real GDP Growth(Advance Release: Q4 2009) Ex. Equipment & Software: -0.5 Source: Bureau of Economic Analysis

25. Contributions to Real GDP Growth(Advance Release: Q4 2009) Source: Bureau of Economic Analysis

26. U.S. House Price Index (Case-Shiller) Nov 0.2% Jan -2.1% Source: S&P, Fiserv, MacroMarkets LLC Note: Composite 10-City Index

27. U.S. Housing Affordability Index Dec 164 Source: National Association of Realtors

28. Mortgage Rates Percent Source: Bloomberg, Bankrate.com

29. Home Sales Noisy Permits & Starts Sideways Source: Census Bureau, National Association of Realtors

30. Home Inventories Lower… But Foreclosures Climbing. Source: Census Bureau, National Association of Realtors, Mortgage Bankers Association

31. The Consumer

32. The Credit Overshoot Has Not Been Unwound BANK LOANS AS % OF GDP 50 % 50 % TREND LINE 40 40 30 30 HOUSEHOLD DEBT-TO-INCOME RATIO 1.4 1.4 TREND LINE 1.2 1.2 1.0 1.0 0.8 0.8 Source: BCA Research 2010, Martin Barnes 1980 1985 1990 1995 2000 2005 2010

33. Annual Consumption Growth Rate Source: Bureau of Economic Analysis

34. Household Wealth 486 404

35. Personal Saving Rate Climbing Source: Bureau of Economic Analysis

36. Investment Spending

37. Business Spending Recovers Slowly Following Recessions Source: Bureau of Economic Analysis, Wall Street Journal

38. U.S. Oil and Gas Rig Counts Rising Source: Baker Hughes, Inc.

39. Capacity Utilization Still Very Low… Source: Federal Reserve Board

40. …But Industrial Production Improving Source: Federal Reserve Board

41. Manufacturing Orders Up Sharply Source: Institute for Supply Management

42. Manufacturing Exports Expanding Reasonably Well Source: Institute for Supply Management

43. Financial Markets

44. Interbank Frictions Mostly Gone 0.12 Source: Financial Times, Reuters

45. A Tale of Two Credit Markets Junk Bond Spread Interest rates charged on credit cards up to 29.99% Source: Merrill Lynch, Federal Reserve Board, Moody’s

46. The Wind Is Beginning To Shift Direction

47. Banks Close to Beginning an Easing of Credit Standards Source: Senior Loan Officer Opinion Survey on Bank Lending Practices (Federal Reserve Board)

48. Long-Term Willingness of Banks to Make Consumer Loans is Increasing Net Percentage of Banks More Willing to Make Consumer Installment Loans more willing 9.6% less willing Source: Senior Loan Officer Opinion Survey on Bank Lending Practices (Federal Reserve Board)

49. The Number of “Problem” Institutions on the FDIC’s List Source: FDIC

50. Monetary Policy