Economic Expansion Continues But Is Starting To Weaken, Hampel Says

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Credit unions should expect strong economic growth in the first quarter of 2006 and two more short-term interest rate increases from the Federal Reserve Board, according to one economist.

Bill Hampel, chief economist for CUNA, noted the U.S. economy is in the fifth year of its expansion following a brief recession in 2001. However, he noted the expansion is weakening, and he expects Gross Domestic Product (GDP) numbers to cool slightly from recent strong levels.

Hampel's forecast calls for 5% GDP growth in the first quarter, which ends March 31, and 3.5% growth for all of 2006. He expects 3% GDP growth in 2007. Inflation also will decline, he predicted: 3% this year; 2.5% next year.

The general trend for long-term interest rates, especially the 10-year Treasury Rate, has been down since 1988, "though it has been erratic," Hampel told attendees of a breakout session at the recent Big Valley Educational Conference here.

When he revealed his prediction for the future path of interest rates, Hampel left himself room for error. The prime rate, as of March 14, was 7.5%. Next year: "it will be somewhere between 2.5% and 25%," he joked.

"No one can forecast interest rates. Seriously, the 10-year Note won't go as low as the 3.2% reached in June 2003. I expect the Fed to raise the Fed Funds rate by .25% the next two meetings. The 10-year Treasury Rate will be 4.6% in 2006 and 4.5% in 2007."

As the Fed has followed a two-year path of interest rate increases-after the Fed Funds Rate reached a generational low of 1%- there has been much discussion in financial circles of the danger of an "inverted" yield curve, where short-term rates are higher than long-term rates. Hampel said the yield curve presently is flat, as the 2-, 5- and 10-year rates all are within "a couple of basis points" of each other.

"Of the last six recessions, all six were preceded by inverted yield curves," he explained. "Only one inverted yield curve was not followed by a recession."

As the Fed pushed up rates, long-term rates have remained low because of foreign investment, Hampel added.

Consumers 'Tired'

One reason Hampel predicts a slowdown in the economy is what he sees as a long-overdue cooling of consumer spending. "The consumer is tired," he declared. "Consumers have been spending like crazy for 15 years. Consumers have been living on borrowed income twice in the last 15 years: stocks in the late 1990s and housing the last four years - which was more widespread than stock ownership. Rising house prices have made people 'feel' wealthier, and have been a huge driver in spending. The negative savings rate is because people feel 'our house is doing the saving for us.'"

"If long-term rates really go up, we'll have a recession, but I don't think they'll go way up," he added.

Hampel said CUs should expect stronger loan growth than savings growth in 2006, which he said would help offset downward pressure on earnings due to the flat yield curve. Net worth ratios will hold steady or rise, because savings growth will be soft. As the economy slows, however, people will save more, he said.

There has been a long downward trend in the CU delinquency rate, dating back to the early 1980s. Hampel said the delinquency rate for California credit unions in 2005 was less than .5%, which he termed "incredibly low."

Perhaps, he suggested, CUs have become a bit too risk averse. "There are two kinds of mistakes credit unions can make with loans. First: make a loan that goes bad. Second: not make a loan that could have paid off."

It is difficult to measure the second error, said Hampel. He said CU boards should not look at chargeoff rates ("This is micromanagement"). Instead, credit unions should "make more loans and risk-based price them. That will increase income. It might increase chargeoffs, but that's okay."

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