The Economic Outlook for 2009 Presented to: APICS: The Association for Operations Management,

1. “It is clear that the U.S. will leave no policy stone unturned in the attempt to put the economic show back on the road, so there should be no Japanese-style lost decade in North America. That is a very positive message for the global economy.” John Plender Financial Times Dec. 24, 2008, p.18

2. “The next few months are among the most important in U.S. history. Because of the financial crisis, Barack Obama has the bi-partisan support to spend $1 trillion in stimulus. But we must make certain that every bailout dollar, which we’re borrowing from our kids’ future, is spent wisely. …If we allow this money to be spent on pork, it will be the end of us.” Thomas L. Friedman New York Times Dec. 24, 2008, p.A21

3. The Economic Outlook for 2009 Presented to: APICS: The Association for Operations Management, Dallas Chapter January 8, 2009 By: Harvey Rosenblum Executive Vice President & Director of Research and Jessica Renier, Research Analyst Federal Reserve Bank of Dallas

4. Overview • Tough year ahead in 2009, noticeable improvement in 2010 • Consumption to bear the brunt of the adjustment • Housing cycle will turn by year-end • Mild deflation likely in 2009 • Monetary policy beginning to work • Fiscal policy and lower energy costs will add to stimulus

5. Themes for 2009 Most likely scenario • Stuck in recession much of the year • Inflation near, or below, zero • Financial headwinds subside, but slowly • Housing correction runs another year • 40% probability

6. Themes for 2009 (cont.) Two other plausible and equally-likely scenarios • Recession ends in Spring 2009 • Credit flows resume • Monetary and fiscal medicine impact quickly • Year of weak growth, but unemployment rate peaks around 8% • 30% probability

7. Themes for 2009 (cont.) • Recession grinds on until Spring 2010 • Banking, financial, and credit headwinds do not subside • Fiscal stimulus takes too long to come and politics/ideology squander its impact • Global economy suffers prolonged negative growth • Monetary stimulus cannot offset a liquidity trap • 30% probability

8. Global Growth Outlook Source: IMF World Economic Outlook, October 2008

9. The U.S. Outlook: 2009-2010

10. Two-Year Growth Outlook Source: Harvey Rosenblum

11. 2009 Quarterly Growth Patterns Source: Harvey Rosenblum

12. Consumption grew from 62.4% of GDP in 1966 to 71.6% of GDP in 2007. • Can this consumption binge be sustained? • No!

13. Shop ‘Til You Drop: The Consumer Has Dropped! *Change from year-end 2007, based on the average of first three quarters of 2008

14. Increase in Unemployment Likely to be Worst in the Post-War Era Note: Stacked bar denotes GS forecast for the current business cycle. Source: Department of Labor and Goldman Sachs

15. Anecdotes on Downward Wage Pressures • Pay freezes • Dell: extended unpaid holiday • Cisco: four-day year-end shutdown • The Seattle Times: unpaid furloughs • Pay cuts • Brandeis suggests professors give up 1% of their pay • No contributions to pensions • Suspended employer match on 401(k) plans • Bonus cuts • Credit Suisse pays bonus in toxic securities • BOA and Citigroup top executives forgo 2008 bonuses

16. Negative Fundamentals Will Weigh on the Consumption Outlook in 2009 • Rising unemployment, job insecurity • Tight credit conditions • Loss of wealth, need to save --------------------------------------------------------------- Bottom line: Consumption will decline in 2009, only the 8th time since 1930? (assuming no decline in 2008??)

17. Time Magazine: June 13, 2005

18. Longest and Deepest Housing Bust on Record *Treats housing slowdowns of ’78:08-’80:06 and ’80:12-’82:02 as separate, and the housing slowdowns of ’87:05-’88:01 and ’89:02-’89:07 and ’90:03-’91:03 as separate.

19. Potential Good News for Housing • 30-year conventional mortgage rate hits 5.10 during week of January 2, 2009, the lowest since 1972. • Refinancing activity is up 136.7% from a year ago. • Mortgage applications up 62% from a year ago. • Home sales in California are up 83% from last year, although prices have had to fall 42%. • Housing affordability, due to mortgage rates, income growth, and lower housing prices, has moved up sharply and is not far from its early '70s high.

20. Nondefense Capital Goods Orders Source: Census Bureau

21. Net Exports Growth Contribution to Real GDP

22. Inflation/Deflation Risks

23. CPI Rollercoaster Headline CPI Forecast: Harvey Rosenblum

24. Pricing: From a Seller’s to a Buyer’s Market Manufacturing Prices Paid Source: Institute of Supply Management

25. Pricing: From a Seller’s to a Buyer’s Market Manufacturing Prices Paid Nonmanufacturing Prices Paid Source: Institute of Supply Management

26. ISM Manufacturing Prices Paid Index Prices paid index at lowest level since 1949: • From 29-year high (91.5) to 59-year low (18.0) in just six months • 14.0 points below previous multi-decade low

27. Inflation fell about 2-3 percentage points during the 1990-91 and 2000-2001 recessions • During the current recession, inflation has already fallen about 4 percentage points from its peak

28. S&P GSCI Commodity Price Index

29. S&P GSCI Commodities Indices

30. S&P GSCI Commodities Indices

31. Bottom line: Perhaps a full year of mild deflation.

32. From Financial Tailwinds (2005) …to Headwinds (2007) …to Gale-Force Headwinds (Sept. 2008).

33. “First, we need to stabilize his spine!” Source: The New Yorker

34. What’s Working • Global banking recap plans have reduced Libor spreads • Fed’s purchase program for GSE mortgage-backed securities has reduced fixed-rate mortgages by 75 b.p. • Fed commercial paper and money market fund facilities show signs of reviving commercial paper market • Low short-term interest rates spurring investors to go to investment-grade corporate bonds

35. Since Oct. 1: • 90-day commercial paper rate down 3.5 percentage points • 3-month Libor rate down 2.7 percentage points

36. Mortgage Rates Came Down Source: Bloomberg

37. Corporate Bond Spreads Hit Historic Highs Source: Federal Reserve Board, Merrill Lynch and Moody’s

38. Fed Easing

39. Federal Reserve’s Growing Balance Sheet (Assets) Securities lent to dealers, including TSLF (off-balance sheet) Week ended: Source: Federal Reserve Board, H.4.1 Release.

40. Money Growth Rates, Last Six Months Annualized • Monetary Base 308% • M1 33% • M2 12.6%

41. Fed Easing

42. A Humble Note “The way events have unfolded over the past few months simply has no precedent… No one knows the outcomes of an unprecedented event. No one.” Zachary Karabell “The Economic News Isn’t All Bleak” Wall Street Journal Dec. 26, 2008, p.A13

43. Fiscal Stimulus • Federal budget deficit expected to exceed $1 trillion this year before special stimulus package • Obama likely to get additional fiscal stimulus of $800 billion spread over ‘09/’10

44. Oil Prices Acting as Tax & Stimulus(based on average annual price, difference from prior yr) 2008 Estimated Losses • to economy: $170 billion • to consumers: $86 billion 2009 Projected Gains • to economy: $355 billion • to consumers: $250 billion

45. Murphy’s Law/Casey’s Law • Murphy’s Law: • If anything can go wrong, it will. • Casey’s Law: • If something can go right, it should.

46. Conclusions • Tough year ahead in 2009, noticeable improvement in 2010 • Consumption to bear the brunt of the adjustment • Housing cycle will turn by year-end • Mild deflation likely in 2009 • Monetary policy beginning to work • Fiscal policy and lower energy costs will add to stimulus

47. Back of Tray

48. This Could Be the Longest Recession Since 1933

49. Manufacturing and Services in a Steep Decline Source: Institute for Supply Management

50. Manufacturing and Services in a Steep Decline Source: Institute for Supply Management