So much for the idea of a recovery this year for the US economy.

The US central bank has sharply downgraded its economic outlook for 2009 and 2010, undermining the view that ‘green shoots’ of recovery are everywhere for all to see.

The Fed says the current slump in the US economy will ”flatten out gradually over the second half of this year and then expand slowly next year” while a senior member of the Fed, Dallas Fed head Richard Fisher, reckons the American unemployment rate will reach 10%.

The Fed minutes support that estimate by revealing it now sees unemployment rising “more steeply’ into 2010 and remaining at a “high level” over the rest of next year.

That’s the gloomiest the Fed and its members have been on the jobless picture so far and indicates it seems America facing more months of 500,000 and more job losses as the unemployment rate rises from March’s 8.5%.

Those ‘green shoots’ everyone is pointing to have failed to convince the forecasters and the Federal Reserve (Even if Fed chairman, Ben Bernanke talked about them in his TV interview on the US 60 Minutes program last month).

Minutes of the latest Fed meeting released three weeks ago reveal the downgrade, and the gloom pervading the boardroom of the world’s most important central bank. The Fed has its next two day meeting at the end of this month.

It’s a burst of pessimistic realism that makes a mockery of the stockmarket drive optimism of stories like this with analysts seeing a case for optimism.

The gloom pervades the commentary in the minutes in all but a few areas. The same attitude can be seen in the Tokyo speech of Richard Fisher. The tone of and descriptors used in the minutes and speech are very, very different to those used by the Reserve Bank Governor, Glenn Stevens, in his statement after this week’s rate cut. Mr Fisher for example, described the data from the US as ‘grim”. Mr Stevens has never had to go that far.

The Fed revealed the downgrade in the minutes, saying:

“In the forecast prepared for the meeting, the staff revised down its outlook for economic activity. The deterioration in labor market conditions was rapid in recent months, with steep job losses across nearly all sectors. Industrial production continued to contract rapidly as firms responded to the falloff in demand,” the Fed said.

“The staff’s projections for real GDP in the second half of 2009 and in 2010 were revised down, with real GDP expected to flatten out gradually over the second half of this year and then to expand slowly next year as the stresses in financial markets ease, the effects of fiscal stimulus take hold, inventory adjustments are worked through, and the correction in housing activity comes to an end.

The weaker trajectory of real output resulted in the projected path of the unemployment rate rising more steeply into early next year before flattening out at a high level over the rest of the year.

“Overall, most participants viewed downside risks as predominating in the near term, mainly owing to potential adverse feedback effects as reduced employment and production weighed on consumer spending and investment, and as the weakening economy boosted the prospective losses of financial institutions, leading to a further tightening of credit conditions.

“Participants expressed a variety of views about the strength and timing of the recovery, however. Some believed that the natural resilience of market forces would become evident later this year.”

Others, who saw recovery as delayed and potentially weak, were concerned about a possible further rise in the saving rate and a very slow improvement in financial conditions. Some participants also cautioned that, because of the poor functioning of the financial system, capital and labor were not being allocated to their most productive uses, and this failure threatened to damp the recovery and reduce the potential growth of the economy over the medium term.”

In Tokyo, Mr Fisher described the US data as “grim”.

Our economy contracted at an annual rate of 6.3 percent in the fourth quarter of last year.

I expect that when the numbers are properly tallied, we will have contracted at a very similar rate in the quarter just ended. Unemployment is rising. We currently have roughly 13.2 million people without jobs, which equates to an unemployment rate of 8.5 percent.

I expect the unemployment rate to continue rising to a level that could surpass 10 percent by year-end. Among other things, this has compounded the problem of the much-watched housing market, where many of the problems we have encountered in our financial markets germinated…the problem with our economy is more pervasive. The men and women who operate our businesses and create and sustain employment have assumed a defensive crouch.

Confronted by dyspeptic financial markets, they are doing the best they can to preserve their margins by cutting costs (most significantly, the cost of labor), and running tight inventories, rationalizing supply lines, deferring all but the most necessary capital expenditures and, in general, avoiding risk. The result is an American economy in stasis. Nothing is being ventured, and nothing is being gained.

Those are not the conditions of an economy on the turn or about to recover.

Peter Fray

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