The pace of economic expansion has slowed over the last few months as early recovery stage inventory restocking, stimulus spending, tax credits, and transfer payments have run their course. US GDP grew 1.7% in the second quarter of 2010, well below historic recovery patterns, and we expect a similar trajectory in the US and other mature economies over the next two to three quarters.

This sluggish pace of expected growth reflects soft demand and excess capacity throughout the economy. Consumers are reluctant to spend with modest income growth, persistently high unemployment, and depressed residential property values. In turn, businesses are disinclined to invest capital in new projects and hire additional workers without stronger order flows and higher capacity usage.

The personal savings rate has increased from less than 2% to close to 6% over the last couple of years, and corporations hold record amounts of cash. Individuals and business enterprises are focused on reducing debt and repairing balance sheets as the economy continues to recover from the excesses of a long and speculative cycle of economic expansion. This process of correction will delay any meaningful rebound in economy activity for some time.

The federal government, and those at state and local levels, will be constrained in any attempts to stimulate the economy because of massive debt levels and falling tax revenues. In any case, government stimulus spending has only temporary effect and will not hasten correction and recovery.

Efforts by the Federal Reserve and other central banks toward further monetary accommodation will be helpful to borrowers by keeping interest rates low, will ensure a receptive market for new government debt issuance, and will maintain high levels of systemic liquidity for the orderly functioning of markets. Otherwise, these accommodations will hedge deflationary forces and add modest stimulus to the economy.

As excesses are corrected over the longer term, we expect growth to accelerate to historic trends, a return of inflationary pressures, and higher interest rates.