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U.S. Economic Commentary and Forecasts: Three Perspectives

JPMorgan Fleming Economic Forecast

The U.S. economy has entered a solid recovery that shows little risk of stumbling into a renewed downturn or "double-dip." We expect GDP growth to average between 3% and 4% during the remainder of 2002, following the strong 5.8% advance recorded during the first quarter. Accordingly, short-term real interest rates will have to be renormalized, substantially higher, during the coming 12 to 18 months. We expect that long-term real yields will also rise significantly in anticipation of - and ultimately in reaction to - the coming Fed-tightening program.

However, the U.S. inflation backdrop remains very benign, which carries two implications. First, it means that the Fed has a strong incentive to allow the U.S. economy to gather strong momentum before taking back the monetary stimulus. Accordingly, we expect no Fed hikes before the August FOMC meeting, and we cannot rule out a delay until later in the year. Secondly, the odds of a major rise in long-term interest rates, exceeding 100 basis points, appear to be low.

The case for a sustained solid U.S. recovery can be distilled into four basic points:

• Macroeconomic policy is stimulative, with short-term real interest rates far below equilibrium and with government spending accelerating rapidly.

• Profits are recovering strongly in response to continued high productivity growth and sustained cost-cutting efforts within corporate America. By the second half of this year, improved corporate finances should spark a recovery in both hiring and capital spending.

• Consumer spending growth should remain firm throughout the remainder of 2002 and into 2003. The reason is that strong productivity growth is sustaining steady gains in aggregate pre-tax real income growth. Meanwhile, the federal government is cutting taxes.

• A continued reversal of the earlier inventory correction will continue to lift production growth. If inventory investment were merely to return to normal by the fourth quarter of 2002, domestic demand growth would receive a lift of more than a full percentage point during each of the next three quarters (on average).

Our current forecast for the Treasury yield curve is as follows.

Treasury Yield Curve Projections

	5/10/02	6-months	12-months
Fed Funds Rate	1.75	2.25	4.00
2-year UST	3.25	4.25	5.25
5-year UST	4.55	5.15	5.85
10-year UST	5.20	5.65	6.10
30-year UST	5.66	6.00	6.25

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