PNC economist predicts rebound to continue through 2010

Banking industry, housing market, consumer savings, retail spending on the rise. Commercial real estate remains murky.

Since the beginning of the year, the U.S. economy has improved significantly. The stock market has roared back to life. Manufacturing indexes have moved upward, with demand increases in both raw materials and finished goods. The housing market has shown some measured improvement. And unemployment has also improved.

There are still challenges looming to continued recovery, including a potential commercial real estate bubble. But many economists are increasingly optimistic on the economic outlook for 2010 and 2011.

Craig Thomas, vice president and senior economist with PNC Financial Services Group, spoke to a group of the bank’s employees at the Wisconsin Club last week. Before the event, he spoke with BizTimes reporter Eric Decker. Below are excerpts of that conversation.

BizTimes: What is your outlook on the economy for the rest of 2010 and into 2011, given the recovery we have seen over the last several months?

Thomas: “2010 is off to a pretty darn good start. I think better than what many people believe. It’s not hard to look around and see high delinquencies, high unemployment and things of that nature, so you want to temper your enthusiasm.

The importance here is looking for a recovery, and a recovery that is sustainable. And that’s what we’re seeing right now. We have two nice solid months of job creation. The majority of the hiring is by private industry. And it’s our expectation that that will continue at roughly the pace we’re at now.

The jobs are the final product, if you will. Underneath it all are the balance sheets and earnings and inventories and trade and all sorts of things that I like to think are sort of the foundation of the economy.

Retail sales are up roughly five percent, vehicle sales are up close to 50 percent year over year. We can see that the foundation of the economy is in better shape. These good signals of retail spending and hiring are a function of lead inventories and stronger production, better earnings. In the case of households you have savings reestablished, good stuff.

When you look forward into 2010, it’s hard not to be optimistic if you’re concentrating on the foundation.”

BizTimes: What is your outlook on the banking industry and commercial lending for the rest of the year?

Thomas: “One of the very important things that has happened over the last couple of weeks is that a new indicator has come out, a survey of senior loan officers. For multiple years you’ve seen a tightening of credit standards across the banking industry broadly. For the first time since (the recession) began, you have a net decrease in lending standards now, across the market, according to this survey.

While it is the beginning of a trend, it indicates that peoples’ risk aversion is starting to diminish as the economy is improving. Terms of lending, I think, are favorable to businesses now. On top of that, the financial industries have more capital. From the banking industry vantage point, my expectation is that much of the most difficult problems facing our financial system have decreased markedly.”

BizTimes: There has been a lot of talk about a potential commercial real estate bubble – is that still a risk to the economy?

Thomas: “We do have a lot of commercial loans and commercial mortgages that are now coming due or need to be refinanced. This is a broad issue across the banking industry. The problem is that commercial real estate has dropped in value, on average, about 50 percent (during the recession).

The question with a lot of commercial mortgages now is that if they are going to be successfully refinanced they likely will need a capital infusion. And so the question is – who is going to provide that?

For smaller banks that tend to have a larger share of either construction loans or commercial mortgages on their books, it could be an issue if they have to take the collateral back as opposed to being able to recapitalize it.

Right now you have essentially 2005 mortgages starting to mature. 2006 will be next year. 2007, which was the peak of the commercial real estate industry, I think there’s a good question of whether or not they’ll ever make it that far. Those were among the most aggressive valuations in real estate.

Certainly, there is the possibility that as the recovery rolls along, as we see building fundamentals improve and vacancies decline, the problem may diminish. But I don’t think you need to say that it’s the type of issue that is going to endanger the financial system such that it would hold back the rest of the economy.”

BizTimes: What do you make of the European financial situation now? How could that affect the U.S. economy this year?

Thomas: “It’s not directly impacting the U.S. in terms of stability in the financial system or even when you think about trade with the globe. While Europe is an important trade partner with the U.S., a lot of the growth is actually in Asia or (South America). It’s not the worst thing in the world.

The Euro has weakened and is likely to continue to weaken. That will make European goods more competitive in our market.

On the positive side, we will likely allow our interest rates to remain low for a longer period of time. Capital has been fleeing the Euro in favor of the dollar. (Investors) have been buying Treasuries.”

BizTimes: The large oil spill in the Gulf of Mexico has dominated headlines for the last few weeks. What affect will it have on oil prices and the U.S. economy this year?

Thomas: “It hasn’t seemed to affect energy prices. It’s an illustration, perhaps, of the cost and benefits of things like offshore drilling. The benefit to the Gulf, as long as things were going well, was that it was a source of jobs and a source of close to home energy. The affect on the price of a gallon of gas maybe was a penny, was probably less than a penny per person.

But the cost when things go wrong is enormous.

What will have a long term affect are the effects on tourism and fishing and to some degree on the reputation for those coastal areas. It’s costing a lot of people their livelihoods.” 

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