Peter R. Fisher, Managing Director and Co-Head of Fixed Income at BlackRock, Presented Today at the Federal Reserve Bank of San Francisco's Asian Banking and Finance Conference

Business Wire, June 18, 2008

The full text of Mr. Fisher's remarks can be found below.

Global Outlook: Something's Gotta Give -- U.S. to Slow in 2009

Federal Reserve Bank of San Francisco

The Changing Landscape: Asia's Role in Global Finance

NEW YORK -- The opinions expressed below are those of Mr. Fisher as of June 18, 2008 and are subject to change as conditions vary.

A few weeks ago, ten-year real rates on inflation protected government securities in both Japan and the United States traded at an identical 1.39 percent. This was not likely to endure and already U.S. real rates are 25 basis points higher than Japan's. It reminded me of the day early in 2000 when US real ten-year rates traded at the same level as Italian nominal ten-year rates. Both then and now, it seemed to me, that the tectonic plates underpinning the global economy would not stay settled long and could shift abruptly, simply put, that something would have to give.

Over the last few weeks, the words and deeds of policy makers around the world have suggested a stronger collective response to the risks of accelerating inflation than was previously evident. But the outcome - how and in what way the plates will shift - remains in doubt.

Today, in contrast to much of the last ten years, the global outlook will be significantly determined by the path of inflation and the policy responses to that path. Having taken significant steps to ease its policy rate and to provide liquidity to the banking system, the Federal Reserve will or will not win its bet that, over the next 12 months, aggregate demand will be sufficiently weak for the U.S. to avoid a sustained acceleration of inflation. At the same time, over the coming year developing Asian economies will or will not restrain their already-elevated levels of inflation. Something has got to give in the tension between aggregate demand, inflation and policy.

I think it likely (but not certain) that the Federal Reserve will be able to avoid a sustained acceleration of inflation and that a year from now U.S. inflation will be falling not rising. This positive outcome will come at a price: domestic demand in the U.S. will start 2009 on a very weak note, as the drags on consumption reassert themselves.

It is harder for me today to see the forces that will restrain and ultimately reverse the inflationary pressures on the Asian continent. I don't know whether inflation will be contained in Asia, but I do know that it will require policy actions or a sequence of events that I cannot now clearly anticipate.

The U.S. economy faces significant drags on consumption that will likely endure the temporary impact of fiscal stimulus. Negative residential fixed investment, reflected in still-falling housing starts, has been subtracting roughly one percent from GDP for over one year. Consumer confidence and personal consumption are being weighed on by the exhausting combination of falling home prices, tighter lending standards, unchanged mortgage rates, rising energy and food prices, and the threat to incomes reflected in rising unemployment and decelerating growth in average hourly earnings.

I believe that federal fiscal stimulus, combined with less extreme swings in inventory and employment levels than many forecasters presume, will provide somewhat stronger growth over the next few months than many have expected, in the range of one to two percent growth in the second and third quarters. But toward the end of the year and going into 2009, as the effects of the stimulus wane, the drags on confidence and consumption are likely to reassert themselves and slow the U.S. economy back toward a zero rate of growth. As these underlying forces of restraint take hold, aggregate demand will likely be sufficiently weak going into next year to avoid a sustained acceleration of inflation and, indeed, to bring inflation down.

There are three important risks to this outlook.

First, in the near term, energy prices might remain elevated for long enough to cause a greater pass through to core inflation and inflation expectations that would be hard to reverse. Exacerbating the situation might be the unintended consequence of fiscal stimulus keeping demand just high enough to sustain energy and food prices at levels that could cause a pass through to core inflation - even if the economy eventually weakens again going into 2009.

Second, if business fixed investment were to pick up over the next few months, this could provide the U.S. economy with greater momentum and correspondingly less likelihood of there being sufficient slack in resource utilization to bring down inflation in 2009.

Third, residential fixed investment and housing prices might bottom sooner than I expect. If housing starts were to bottom before year end, we would avoid this continued drag on GDP. If home prices were to bottom, we might stabilize consumer confidence.

While most housing recoveries have been sharp and V-shaped, it is hard to for me to see how this occurs without there first being in place more generous financial conditions for consumers. Thus, a significant factor influencing my outlook for the U.S. economy to weaken again, in addition to a payback from stimulus, is my expectation that our financial system will remain quite weak and consumer credit relatively scarce and costly.