Economics Report
U.S. Economic Outlook
Bubble Trouble or Goldilocks ?
David Greenlaw, Chief U.S. Fixed Income Economist
May 2007
Economics Report
Forecast at a Glance
2004
2005
2006
GDP Growth(1)
3.4
3.1
3.1
2.1
3.1
Core CPI Inflation(1)
2.1
2.1
2.7
2.4
2.1
Budget Surplus (% of GDP)
-3.6
-2.6
-1.9
-1.3
-1.1
Fed Funds Rate(2)
2.25
4.25
5.25
5.25
4.75
10-Year Note Yield(2)
4.24
4.39
4.71
4.90
4.75
2007e
2008e
Notes: (1) Q4/Q4 Percent Change
(2) End of period
e = Morgan Stanley Estimate
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
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2
Economics Report
The US Economy Has Demonstrated Impressive Resilience
Estimated Damage Caused By Major
Weather Events, 1980 – 2005 (Billions of 2005$)
Crude Oil Prices
(WTI $/bbl)
75
140
70
120
65
100
60
55
80
50
60
45
40
40
35
20
30
25
0
Katrina Andre w Hugo Charlie
05
92
89
04
Ivan
04
France s Blizzard
04
of the
Ce ntury
93
Source: National Climatic Data Center and Risk Management Solutions
20
00
01
02
03
04
05
06
07
Source: Haver
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
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3
Economics Report
The Latest Hurdle for the Economy
Subprime Mortgage Delinquency Rate
Lending Standards
(Percent)
(Net Percentage of Institutions Reporting a Tightening)
15.0
70
Mortgage
14.5
60
C&I
Tightening (+)
Credit Cards
14.0
50
13.5
40
13.0
30
12.5
20
12.0
10
11.5
0
11.0
-10
10.5
-20
10.0
-30
98
99
00
01
02
03
04
Source: Mortgage Bankers Association (data through Q4)
05
06
Easing (-)
90
92
94
96
98
00
02
04
06
Source: Federal Reserve, Senior Loan Officer Survey. Latest data point is
from the January 2007 survey.
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
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4
Economics Report
Job Growth Has Helped Fuel Gains in Personal Income and Spending
Job Growth
The Link Between Income and Spending
(Average Monthly Payroll Change, Thousands)
(Year/Year Percent Change)
250
9
200
8
7
150
6
100
5
50
4
0
3
-50
2
Consumer Spending
-100
1
-150
Wage & Salary Income
0
00
Source: BLS
01
02
03
04
05
06 07ytd
91
93
95
97
99
01
03
05
07
Source: BEA
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
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5
Economics Report
The Labor Market Still Looks Healthy
Employment and Tax Collections
Jobless Claims
(Year/Year Percent Change)
(4-Week Average, Thousands)
16
4
500
Nonfarm Payrolls (Left)
Withheld Taxes (3-Mo Avg, Right)
3
12
2
8
450
400
4
1
350
0
0
-1
-4
-2
-8
98
99
00
01
02
03
Source: BLS and Daily Treasury Statement.
04
05
06
07
300
250
89
91
93
95
97
99
01
03
05
07
Source: Department of Labor
Note: Shaded areas indicate recessions.
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
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6
Economics Report
Bubble Trouble in the Housing Market?
Home Prices and the Business Cycle
Housing Affordability Index
(OFHEO Index Adjusted for CPI Inflation)
(Index, Base=100)
210
160
Nationwide
West
200
140
190
180
120
170
160
100
150
140
80
130
120
60
110
89
75
78
81 84
87
90 93
96
99
Source: OFHEO and BLS. Shaded Areas indicate recession
92
95
98
01
04
07
02 05
Source: National Association of Realtors w/ MS calculations.
Note: Actual series plotted through March with estimates through the
end of 2008 assuming a 5% decline in home prices.
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
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Economics Report
How Big is the Wealth Effect?
Household Net Worth
Average Contract Rate on All New
Mortgage Loans Closed (Percent)
(Percent of DPI)
650
13
12
600
11
10
550
9
500
8
7
450
6
400
5
85 87
89 91
93 95
97
99 01
03 05
Source: Federal Housing Finance Board. Data plotted through March.
07
60
66
72
78
84
90
96
02
08
Source: Federal Reserve
Note: Actual series plotted through 2006 Q4, with estimates for the ensuing
year based on a 5% drop in home prices and a flat equity market.
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
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8
Economics Report
The Wealth Effect versus An Energy Shock
Wealth Effect
Household Real Estate Assets = $20 trillion.
•
• Assume Home Prices Drop 5%.
• “Standard” Wealth Effect implies a $40 bil (or 0.4%) hit to consumer spending. 1/
Energy Shock
Gasoline and fuel oil account for about 4% of total consumer spending. 2/
•
• Assume Gasoline Prices Decline from $3/gal to $2.25/gal.
• This adds $90 bil (or 1.0%) to discretionary spending power.
1/
The wealth effect of 4 cents per dollar of change in wealth is based on the econometric model of the US economy that
is used by the Federal Reserve Board. Recent research suggests that the housing-specific wealth effect may be even
smaller. See “The Decline in Household Saving and the Wealth Effect” by Juster, Lupton, Smith and Stafford.
2/
Does not include household fuels such as natural gas.
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
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Economics Report
A Correction In Residential Construction Is Well Underway
Residential Investment
Single-Family Housing Starts & Completions
(Percentage Point Contribution to Quarterly GDP Growth)
(Thousands, SAAR)
1.5
2000
Starts
1.0
1750
Completions
0.5
1500
0.0
1250
-0.5
1000
-1.0
750
-1.5
500
-2.0
98
99
Source: BEA
00
01
02
03
04
05
06
07
85
88
91
94
97
00
03
06
Source: Census Bureau
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
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Economics Report
The Cap-ex Mystery
Corporate Profits and Capital Spending
Business Investment as a Share of GDP
(Percent Change From Year Ago)
(Percent)
30
14
S&P 500 EPS
Business Investment
25
20
13
15
10
12
5
0
11
-5
-10
-15
10
Average 1970 to Present
-20
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
-25
Source: S&P and BEA (note: capital spending series is nominal business
fixed investment).
9
70
74
78
82
86
90
94
98
02
06
Source: BEA
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
Please see the important disclosures at the end of this report.
11
Economics Report
Still on the Inflation Watch
Rent Increases May Be Peaking
(Percent)
Core Inflation
(Percent Change From Year Ago)
3.0
11
5
Apt Vacancy Rate (Left)
CPI for Rent (Right)
10
2.5
4
2.0
9
1.5
8
3
1.0
7
Core CPI
Core PCE Price Index
2
6
0.5
00
01
02
03
04
05
06
07
Source: BEA and BLS (note: PCE data plotted through February)
88
90
92
94
96
98
00
02
04
06
Source: Census Bureau and BLS
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
Please see the important disclosures at the end of this report.
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Economics Report
Labor Cost Pressures Are Building
A Mixed Track Record
Unit Labor Costs and Inflation
(Percent Change From Year Ago)
(Year/Year Percent Change)
CPI for Energy (Left)
Core CPI (Right)
50
14
14
Unit Labor Costs
Core CPI
12
12
40
10
30
10
20
8
6
10
6
4
0
4
8
2
0
-10
2
-20
0
70
74
78
Source: BLS
82
86
90
94
98
02
06
-2
-4
60
65
70
75
80
85
90
95
00
05
Source: BLS
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
Please see the important disclosures at the end of this report.
13
Economics Report
Where are the Bond Market Vigilantes?
Getting to Neutral
Market Pricing of a Rate Cut by June
(Percent)
(Implied Probability Based on July 07 Fed Funds Futures)
12
Real Fed Funds Rate (Based on Core PCE)
Average, 1960 - Present
10
100
90
80
8
70
6
60
4
50
2
40
0
30
-2
20
-4
10
-6
60
65
70
75
80
85
Source: Federal Reserve and BLS
Note: Shaded areas indicate recession.
90
95
00
05
0
1/2/07
1/24/07 2/14/07
3/8/07
3/28/07 4/18/07
Source: CBOT
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
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14
Economics Report
Is There Still a “Conundrum”?
Real 10-Year Treasury Note Yield
Global Savings Rate
(Nominal Yield Less 3-Yr Weighted Average Core CPI)
(Percent)
8
26
New Estimates
7
25
Prior Estimates
6
24
5
4
2.7% Long-Run Avg
23
3
22
2
1
21
0
20
-1
58 62 66 70 74 78 82 86 90 94 98 02 06
Source: Federal Reserve and BLS with Morgan Stanley calculations.
81 83 85 87 89 91 93 95 97 99 01 03 05
Source: IMF
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
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Economics Report
The Dominant Role of the Foreign Investor
Foreign Ownership of Treasuries, by
Maturity
Financing the U.S. Budget Deficit
(Billions of Dollars)
Domestic Owned
1000
Foreign Private Owned
900
Cumulative Budget Deficit,
FY 2002-06
$1516 billion
Foreign Official Owned
800
Net Purchases of Treasuries, FY 2002-06
700
600
Federal Reserve
$225 billion
500
Foreign Central Banks
$438 billion
400
Private Foreign Investors
$846 billion
300
Total
$1509 billion
200
100
0
Bills
0-2 Yr
3-5 Yr
6-10 Yr
11+ Yr
Note: Data as of June 2005. Excludes Fed holdings.
Source: Morgan Stanley calculations based on US Treasury Dept data.
Source: Treasury Department, TICS Survey, Federal Reserve, and Morgan
Stanley estimates
David Greenlaw . (212) 761.7157 . David.Greenlaw@morganstanley.com
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Economics Report
Infrastructure Spending Has Accelerated In Recent Years
State and Local Government Investment
Muni Yields Tend to Track Treasuries
(Year/Year Percent Change)
(Percent)
20
16
15
14
10
12
5
10
0
8
-5
6
-10
4
80 82 84 86 88 90 92 94 96 98 00 02 04 06
Source: BEA
Bond Buyer Muni Index
20-Year Treasury Bond Yield
80 82 84 86 88 90 92 94 96 98 00 02 04 06
Source: Federal Reserve
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Economics Report
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