President Barack Obama, flanked by former Federal Reserve chairman Paul Volcker, left, and General Electric CEO Jeffrey Immelt, right, comments during the Economic Recovery Advisory Board meeting in the Roosevelt Room of the White House Wednesday, May 20, 2009.

The top economists at US investment bank Morgan Stanley, Richard Berner and David Greenlaw, say in their latest commentary that the rise in the unemployment rate to 10.2% in October and steady declines in payrolls casts doubt on the sustainability of the new recovery. They say that the employment-economy disconnect can't continue indefinitely; either the economy will slow significantly or labour markets must improve. They still see the recovery as sustainable, if moderate; stronger incoming data prompted them to raise their overall Q4 growth estimate from 2% annualised last month to 3% currently. They expect the Fed to raise rates in Q3 2010 while new jobs hiring will improve in early 2010. Meanwhile General Electric's chief executive signalled on Monday that he expects a second economic-stimulus package.

General Electric's chief executive Jeffrey Immelt and Bank of America Merrill Lynch executives said Monday they expect Congress to approve a second economic-stimulus package to support a slow economic recovery.

The speakers, on a BofA Merrill Lynch webcast, said global economic recovery would be led by governments and emerging markets.

“If you look at where we were a year ago, without a stimulus plan we wouldn’t be where we are today, talking about a recovery,” said Michael Hartnett, chief global equity strategist at BofA Merrill Lynch Global Research. Harold Ford Jr., a former congressman and vice chairman of BofA Merrill Lynch, predicted a second stimulus will take place sometime next year.

“It’s going to be hard to solve some of these problems - -- unemployment and otherwise,” said Immelt. He said a second stimulus should address the US’s excess industrial capacity and loss of jobs.“There’s some challenges.”

“Right now, the economy is still very much in the intensive [care] ward,” said Ethan Harris, head of North America Economics at BofA Merrill Lynch Global Research. He expects a second stimulus package because both political parties will want something to show heading into the 2010 mid-term elections. “If you can get some job growth, you will have something to show for it.”

Nouriel Roubini, the economist known as Dr. Doom, who is a professor at New York University, warned in an article in the New York Daily News on Monday, that “job losses will continue until the end of 2010 at the earliest. In other words, if you are unemployed and looking for work…you had better hunker down…The jobs are just not coming back….Based on my best judgment, it is most likely that the unemployment rate will peak close to 11% and will remain at a very high level for two years ore more….The damage will be extensive and severe unless bold policy action is undertaken now.”

Last week, David Rosenberg, a former chief North American economist at Merrill Lynch, said the US unemployment rate is headed for 12%-13%.

“There are serious structural issues undermining the US labour market,” he said in a note to clients of Toronto broker Gluskin Sheff & Associates, Wednesday , emphasising that the surge in unemployment resulting from the Great Recession is only part of the problem.

He points out that beyond those who are counted as officially unemployed, “there are the record number of people [about nine million] who got furloughed into part-time work,” plus many more who have dropped out of the labour force altogether.

SEE: Finfacts report, Nov 06 2009: US unemployment rate rises to 10.2% in October - - the highest since April 1983; Broad measure of unemployment surges to 17.5%

Jan Hatzius, chief economist at Goldman Sachs, has suggested that unemployment could hit or even surpass 11%.

However, Joseph LaVorgna, chief US economist at Deutsche Bank, said in a client note Wednesday that the unemployment rate could peak before the end of this year and start to fall.

“We believe we could be closer to a peak in the unemployment rate than some analysts expect,” he said. “For starters, it is worth noting that unemployment tends to keep rising until it suddenly reverses and begins moving back down…whenever the unemployment rate turns many market participants may miss it.”

“More important…the peak in unemployment duration as measured by the number of people employed between 5 to 14 weeks is an excellent leading indicator of the labor market,” he said. “In the past, this series peaks one quarter ahead of the unemployment rate. [So] if history repeats, the unemployment rate should peak this quarter.”

Meanwhile, in an unusual move, the Federal Reserve chairman on Monday made a direct comment in support of the dollar.

The Federal Reserve is monitoring currency markets “closely” and will conduct policy in a way that will “help ensure that the dollar is strong,” Ben Bernanke said on Monday.

In remarks directed at reassuring markets and foreign governments that the central bank is not indifferent to the fate of the US currency, the Fed chairman said “we are attentive to the implications of changes in the value of the dollar.”

He added that the Fed “will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability” - - and that in doing so it would support the value of the currency.

The Morgan Stanley economists say that they still believe that the Great Labour Market Recession will soon be over.  The reason: As the economy grows, a hiring overhang has become a deficit.  They also says that they are  mindful of the risks on either side: Uncertainty over healthcare reform could prolong the hiring drought.  But a job tax credit is now more likely, in their view. 

Stronger productivity gains and increased slack in labour markets also prompted them to reduce their 2010 inflation forecast. 

"We now see the unemployment rate peaking at 10.5% in the first quarter, and productivity growth averaging 3.8% over the course of 2009-10, both half a point higher than last month.  As a result, we expect core inflation measured by the CPI to run at 1.4% over the four quarters of next year, compared with 1.7% last month,"the economists say and add: "We still believe the Fed will begin raising short-term interest rates in Q3 next year, reflecting greatly improved financial conditions and a sustainable recovery.  However, that lower inflation outlook prompted us to trim our Fed call for 2011.  We now see the Fed pausing over much of 2011 after lifting the funds rate to 2% early in the year.  Together with heavy Treasury coupon issuance, that stance should promote a resteepening of the yield curve over the course of 2011."

Incoming data stronger, speak to sustainability:Third-quarter growth was in line with MS' expectations, but incoming data for consumer spending have been significantly stronger than expected.  Last month, MS expected paybacks from the cash-for-clunkers car rebate program, to linger and weak income to hold growth in spending to an anemic 1% rate in Q4.  But a better-than-expected ramp tied to surprising strength in non-vehicle spending in September and stepped-up October retail and vehicle sales prompted the economists to boost their estimate for Q4 consumer spending growth significantly to +2½%, even with very conservative end-of-year spending assumptions.  However, they still see tepid income gains continuing to exert some restraint on spending and expect a desire to rebuild saving to cap gains through 2011 and beyond, so they made no changes to their growth projections for 2010-11. 

The weakness in labour markets threatens the sustainability of recovery:  Payrolls tumbled by 190,000 in October and the unemployment rate posted a big jump to 10.2% - - the highest since early 1983.  The economists say the October decline is in line with the 188,000 average monthly drop over the past three months, the smallest since August 2008.  However, job loss in important sectors such as construction, manufacturing and retail trade was heavy in October.  Moreover, including forthcoming revisions to the payroll data, it brings the decline over the 22 months since the recession began to a record 5.9%, eclipsed only by the collapse following the end of war production in 1945.  And the private workweek remained at a record-low 33 hours. 

"We see this weakness as mainly cyclical, exaggerating the time-honoured, early-stage surge in productivity that has characterised every expansion.  But there is also a secular component: We think US trend productivity growth is still running at around 2%, in contrast with concerns of a relapse,"the economists says.

Despite that changed relationship, MS continues to expect that job growth will appear in early 2010:  The key reason is that past job cuts have virtually eliminated what were minimal hiring excesses, and a growing economy has produced a hiring deficit. The recession has taken the level of private payrolls about 500,000 below the trough of the previous recession in mid 2003, while the economy has since grown by nearly 11%.

Encouragingly, the economists say that there are scattered signs that the long slide in employment and hours may be nearing an end.  Notably, temporary help payrolls, often considered to be a leading indicator of labour demand, jumped by 40,000 in the past two months, the largest such rise since 2005.  In addition, the August and September levels for overall payrolls were revised up by an unusually large 90,000; upward revisions are often a sign of improvement.  Other leading indicators are also improving: Initial and continued claims for unemployment insurance benefits have declined steadily since peaking in June; the employment components of the two ISM (Institute of Supply Management) Indexes and stability in the private job openings rate over the past three months seem consistent with smaller declines in payrolls; and surveys of hiring and hiring plans such as those from our own Business Conditions Survey (the MSBCI) in early October improved noticeably.  And factory regular and overtime hours have risen steadily since the spring.  Encouragingly for income, average hourly earnings rose by 0.3% in October, so the economists expect a 0.2% gain in overall personal income for Q4.

Unemployment worries:  Nonetheless, the economists say the sharp jump in the unemployment rate is worrying, and they now expect that the unemployment rate will peak at 10.5% in the first quarter of 2010, half a point higher than a month ago.  Rising joblessness typically erodes credit quality and makes lenders cautious.  Long spells of joblessness erode worker skills and thus the odds of being rehired, as well as consumer confidence.  Moreover, declining labour-force participation had until October held the unemployment rate down; in the past three months, the household survey measure of employment declined by an average 589,000.  That string of large employment declines represents an important source of concern. 

Policy risks: One plus, one minus.  Catch-up or not, the sharp jump in the unemployment rate is likely to spur policymakers to consider new measures to stimulate job creation.  For example, after the September report, talk of enacting a new job tax credit surfaced in Washington.  The economists say that such a measure - - if designed correctly - - could be an important temporary source of effective stimulus.  However, this is a politically divisive initiative.  Liberals find such tax credits distasteful because they involve government writing a check to corporations, and conservatives see such measures as more government meddling in the private sector.  Last week, in a meeting between President Obama's chief economic adviser Larry Summers and House Democrats, Summers reportedly raised the possibility of a new job tax credit but members of Congress quickly shot down the idea.  Coupled with the results of last week's state elections, the jump in the jobless rate may alter the political dynamics, but it's unclear how the policy debate will play out, the economists say.

On a related front, the MS economists say that they are becoming increasingly concerned that uncertainty tied to healthcare reform may be restraining hiring at small and medium-sized businesses.  Under the just-passed House plan, would-be employers who do not currently offer healthcare benefits to their employees are required to choose between introducing a plan and paying a hefty tax.  In contrast, the Senate plans do not include such an employer tax.  Why hire until the dust settles on those proposals?  Employers needing more labour input could respond by boosting the workweek and avoiding full-time hires (the former will probably happen over the next couple of months anyway, and the recent pickup in temp hiring may reflect those concerns).  Unfortunately, given the sharp differences between House and Senate healthcare bills, it appears that this uncertainty won't be resolved any time soon, the economists say.

Fed to start raising rates in 2010, but expected to pause for much of 2011:  Reflecting a sustainable recovery and a bottoming in inflation by mid 2010, the economists expect the Fed to begin raising rates in Q3 2010.  But instead of continuing to raise rates, they now expect the Fed to pause early in 2011, after lifting the funds rate to 2% early in the year.  Among the reasons: improved productivity growth, correspondingly more slack in labour markets, and a lower 2010 inflation trajectory.  That's consistent with the Fed's conditional promise to keep rates exceptionally low for an extended period.  The Fed last week added explicit conditions to that promise: "The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period."  Given the MS outlook, even the move to 2% would keep the real federal funds rate at or below zero through 2011, which is viewed as exceptionally low.

Fed Chairman Ben Bernanke discusses the economy and employment in front of the members of the Economic Club of New York, Monday, Nov. 16, 2009: