Where the Market Sees the Economy Moving in 2009

It is time to take stock of where the market sees the economy moving in 2009. Let’s examine

• Overnight Index Swap (OIS) Futures - tracking the effective Federal Funds rate
• Three month Eurodollar Futures - tracking three month LIBOR - the base private lending rate
• Oil Futures - tracking energy
• Dow Futures tracking industrial performance

Let’s start with the base of the economy, the effective Fed Funds rate. By reviewing OIS Futures, the market believes by the fall of 2009, the Fed will have increased the target funds rate to 0.5%. Further, economic activity will be strong enough that the effective rate will mirror the target rate by both the midyear and by the end of the year. Treasuries expiring in December 2009 yield 0.41%, according to the Wall St. Journal, close to the effective funds rate Dec-09 futures.

Three month Eurodollar futures, a mirroring instrument to three month LIBOR trading on the CME, state marginal increases in lending cost. Considering Treasuries expiring in March 2010 yield 0.4% (compared to Treasuries expiring in December 2009), there is still a very high TED Spread - the private capital trust spread -by the end of 2009.

Oil futures - according to the Wall St. Journal - show robust increases in energy cost. Further, according to the WSJ, there is no change in dollar futures against a world currency basket through 2009. This shows a pickup in world oil demand, potentially a pickup in global economic growth.

The Dow, however, points down. This could be explained in two ways:

• The first is inflation. According to the FT, the 5-Year Treasury Bond trades at 1.51%. According to the WSJ, 5-Year TIPS trade at 2.65%. Declining prices mean declining profits, which pushes down share prices. Declining prices coupled with increasing energy further pressures profits.
• The second - compounded with deflation - is the cost of debt. Fair to say, this fall was miserable for bond offerings. This past week was positive - companies actually went to market- see here - but for those companies able to issue debt, it is expensive, especially relative to Treasuries -as mentioned before - of similar duration.

In 2009, the market predicts a start to economic recovery. That the Fed Funds effective rate will mirror the target rate and that the target rate will increase by end of 2009 shows positive economic activity. While three month LIBOR is low through 2009, the actual cost of debt to firms - both in spreads and the growth/contraction in inflation - still puts long term pressure on economic growth.

Comments

[Prudent Man...:]

Can the market see ahead? What did it see in last year? 1999? 1981? The ability of the market to discount is not only sophistry it is a fraud and the evidence is right in front of any objective analyst.

I just want facts not opinions so I read the facts and gloss over opinions.

Jan 14 08:33 AM

[know nothing:]

It appears they are ignoring the oil production cuts,which should raise oil prices in 2009,taking a good share of any potential future profits that could assist the recovery process,and they are ignoring all the other struggling countries who are in bail out mode just for survival! Theres not much room for growth when the world seems to be in survival mode! When december retail sales fall as much as they did, (Dec typically being the strongest retail sales) What is Jan, Feb, March, going to look like? Did everyone forget about the unemployment numbers from Dec? Don't forget the new scam called "CRAMDOWN" if this takes effect,look out!! What lending institution will lend to any consumer, when a bankruptcy court can wipe out a portion the original mortgage? This would be a banking disaster of unprecidented proportions! I'll believe a recovery in "09" when I see it! We have a long road to hoe.

Jan 14 10:13 AM

[John Lounsbury:]

Dave - - -

Your conclusion is interesting: "In 2009, the market predicts a start to economic recovery."

This can be compared to Steven Hansen's article (seekingalpha.com/artic...)
which shows a CBO estimate that the recession will bottom by 3Q/09 and projects a return to normal growth by mid-year 2010.

The CBO projection and yours are in close agreement for the start of recovery. Both are more optimistic than I am yet ready to believe. But I have to keep looking at what those with different views than mine have to say or, in isolation, I could talk myself into never-never land.

Jan 14 11:13 AM

[Bad Dog:]

The talk of recovery in 2009 is really just good old-fashioned denial. We are shedding in excess of 500,000 jobs per month. Retail sales have been falling worse than expected. Wages are falling too. There is a deflationary tsunami building now, and we haven't seen a crest yet. Look for the next month's job loss number. I expect it to remain at 500,000. If that rate is maintained to mid-year, it will finally break through the denial mentality in the US and people will at last accept that we are in the midst of a huge deflationary depression. This can be ameliorated by government action but not prevented.


On Jan 14 10:13 AM know nothing wrote:

> It appears they are ignoring the oil production cuts,which should
> raise oil prices in 2009,taking a good share of any potential future
> profits that could assist the recovery process,and they are ignoring
> all the other struggling countries who are in bail out mode just
> for survival! Theres not much room for growth when the world seems
> to be in survival mode! When december retail sales fall as much as
> they did, (Dec typically being the strongest retail sales) What is
> Jan, Feb, March, going to look like? Did everyone forget about the
> unemployment numbers from Dec? Don't forget the new scam called
> "CRAMDOWN" if this takes effect,look out!! What lending institution
> will lend to any consumer, when a bankruptcy court can wipe out
> a portion the original mortgage? This would be a banking disaster
> of unprecidented proportions! I'll believe a recovery in "09" when
> I see it! We have a long road to hoe.

Jan 14 01:46 PM

[Larry House:]

Interesting observations, John Lounsbury. If you want to check out some ideas opposing a return to growth in '10, check out Harry S. Dent and his new book, The Great Depression Ahead. He is interviewed here in SeekingAlpha today. I don't follow any set of ideas totally; I prefer to sift through the ideas of many.

Jan 14 03:52 PM