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Unemployment clouds US recovery

THE US economy will continue to recover from the worst slump since the Great Depression, say Wall Street analysts, but unemployment will remain high during the new year and the meltdown of the housing market shows few signs of ending.

The United States is emerging from recession faster than Britain due to a big federal government stimulus programme as well as a recovery in the manufacturing and the banking sectors.

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Many economists have pencilled in growth of between 3% and 4% for the world’s biggest economy during the next 12 months.

However, the dollar’s strong gains in the final weeks of 2009 and the improvement in the US economy – personal incomes rose in November at the fastest pace in six months – have led traders to weigh chances that the Federal Reserve might begin raising interest rates sooner than they had expected. This would act as a damper on economic activity.

High unemployment is one factor keeping the Fed from nudging up the cost of borrowing, currently at a record low range near zero, among the lowest in the world. The latest available unemployment figures – for November – indicate 10% of the workforce is jobless.

It is relatively cheap for investors to borrow dollars, and analysts say traders are using the dollar to fund “carry trades”, which weigh on the currency. In a carry trade, an investor borrows dollars in order to buy higher-yielding assets and makes money on the difference in interest rates.

But if unemployment falls faster than expected, that could prompt the Fed to start raising rates sooner than analysts expect, which has been the second half of next year or perhaps even 2011.

Investors are “reassess(ing) the trajectory of Fed policy in light of evidence of light at the end of the tunnel of long and deep job losses,” said Marc Chandler of Brown Brothers Harriman, and an interest-rate rise in the second quarter of 2010 “is not being ruled out”.

Once the Fed starts pushing up rates and curbing its extraordinary asset purchases, “we expect the dollar to find great traction”, Chandler said.

In early December, the Labour Department said the unemployment rate for November fell to 10% from 10.2% in October. Employers also cut the smallest number of jobs since the recession began. The economy shed only 11,000 jobs. The data “is a sign that the economic recovery may be gathering momentum”, said analysts from research firm Capital Economics in a note. But they cautioned that “five months after the recession ended, the economy is still shedding jobs”.

The dollar over the past year and a half has tended to trade inversely to stocks as investors sought a haven amid a meltdown in riskier emerging markets and US equities. Buying the dollar allows investors access to the super-safe, extremely liquid market for short-term US Treasuries. Since March, the low-yielding dollar has suffered as stocks, commodities and emerging-market currencies soared as investors become increasingly confident with the idea of global recovery.

That relationship may finally be winding down, said Matthew Strauss, senior currency strategist at RBC Capital in Toronto. As the risk of a double-dip recession in America recedes, he said, investors are going to be increasingly comfortable buying the dollar due to better-than-expected economic and corporate data.

“As the economic recovery gains traction... the market is becoming more comfortable in following data more along the economic fundamentals,” he added. Strauss concurred investors were also pricing in the possibility that the Fed would raise rates sooner than the second half of next year if the job market continues to improve.

Meanwhile, the UCLA Anderson School of Management’s economic report predicts an average quarterly growth of 2.7% in 2010 and an average of 4.1% in 2011. Princeton University economist Alan Blinder, writing on the Wall Street Journal’s website in mid-December, was more bullish, saying the US economy may expand by 3% to 4% in 2010 supported by a recovery in investment, job creation and fiscal and monetary stimulus.

David Shulman, senior economist with the UCLA project, said recovery in the labour market is expected to be slower than in the broader economy, with 7.5 million jobs lost through the entire recession as the unemployment rate rises to 10.5% in the middle of 2010. By the end of 2011, employment is forecast to total four million jobs below the employment peak in 2007, and the jobless rate still above 9%.

“We still forecast a tepid recovery in 2010 as the contractionary forces become spent – housing can’t get much lower – and the near-term positive impacts of monetary and fiscal policy take hold,” wrote Shulman.

Other economists hold more bearish views on the US housing crisis, saying the meltdown in the market, which helped spark the global financial crisis of 2008-09, is not over yet and property prices will soon start falling again.

Mark Zandi, chief economist at Moody’s Economy.com is predicting foreclosure sales will pick up again in the New Year and as a result property prices will resume their decline. The US housing market has suffered the worst downturn since the Great Depression and its impact has rippled through the recession-hit economy and the world.

A setback for the real estate market could portend problems for the US economy as a whole.

Property prices in many regions have been rising in recent months as foreclosure sales declined during the summer months and mortgage servicers have tried to put those facing losing their homes into the government’s affordable home loan programme, so they don’t lose their property.

Zandi though is not confident this will continue. “The housing crash is not over yet. Foreclosure sales will increase and home prices will resume their decline by early 2010 as mortgage servicers figure out who will not qualify for a modification loan,” he explained.

Property prices, as measured by the Standard & Poor’s/Case-Shiller US National Home Price Index, will trough in the third quarter of 2010 after falling by 38%, Zandi added.

He is predicting around 7.5 million foreclosure sales will have taken place between 2006 and 2011. The majority, however, have not emerged yet, with 4.8 million foreclosure sales expected between 2009 and 2011.

Zandi said another significant obstacle to a housing market recovery is the number of mortgages that are underwater, where borrowers owe more for the loan than the residence is worth. This negative equity disqualifies many homeowners from refinancing and prevents some from selling their homes. Borrowers in negative equity are also more prone to defaults and foreclosures.

Overall there are also concerns about the effect of unemployment on the real estate market.

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