May 10 (Bloomberg) -- The U.S. economy will expand more than previously estimated as jobs and rising incomes overcome any drag from the European debt crisis, according to economists at Morgan Stanley.
Gross domestic product will rise 3.5 percent in the fourth quarter of 2010 compared with the same period last year, and increase 3 percent next year, according to revised forecasts issued today by the bank’s economists in New York, headed by Richard Berner and David Greenlaw. The projections were up from prior estimates of 3.2 percent and 2.5 percent respectively.
The world’s largest economy is shifting “from reliance on the strength of global growth to domestic forces of output, employment and income gains that make recoveries self-sustaining,” the economists wrote in an e-mail to clients. If it weren’t for the European debt crisis, “we would likely make more significant upward revisions to our outlook.”
Employers added 290,000 workers to payrolls in April, the most in four years, data from the Labor Department showed last week. Revised figures also showed the economy gained jobs in each of the first four months of the year.
Stephen Roach, chairman of Morgan Stanley Asia Ltd., was less sanguine about the outlook. The fallout from the European debt crisis raises the risk of a “double dip” recession for the global economy, he said in an interview today on Bloomberg Radio with Tom Keene.
“When you have a vulnerable post-crisis economic recovery and crises reverberating in the aftermath of that, you have some very serious risks to the global business cycle,” he said.
One casualty of the mounting risk a European government defaults on its debt will be inflation, Berner and Greenlaw said, citing declining measure of price expectations. For that reason, the analysts projected Federal Reserve policy makers will now wait until early 2011 to start raising the benchmark interest rate, rather than in September as they previously estimated.
“The threat of contagion from the sovereign credit crisis does pose a clear downside to our sustainable growth scenario, and with inflation low, gives the Fed ample reason to wait and make sure the risk is limited,” according to the e-mail.
The yield on the 10-year Treasury note will end the year at 4.5 percent, down from a previous estimate of 5.5 percent, the economists said. The notes yielded 3.54 percent at 1:06 p.m. in New York today.
The Morgan Stanley economists also predicted the spread between short- and long-term rates, known as the yield curve, will steepen this year as the former remain near zero and the latter climb. The curve will then see a “significant flattening” in 2011 as the Fed is forced to boost the target rate on overnight loans between banks to 2.5 percent by the end of the year, swamping their projected half percentage-point increase in the 10-year note yield to 5 percent.
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