Monday, November 26, 2007

2008 Recession Outlook

Peter McKay & Kelly Evans:

Battered stock and bond markets are sending an increasingly ominous signal that a U.S. recession could be near.

The markets, however, haven't swayed Federal Reserve officials and most private economists from their view that the nation's economy can escape a downturn and get back on a steadier course.

The disparity between those two views of the economy -- one growing bleaker, the other remaining sanguine -- stood out starkly last week.

Though it rose during Friday's shortened trading day, the Dow Jones Industrial Average -- at 12980.88 -- is 8.4% below its all-time high, set in October. Safe-haven Treasurys, meanwhile, have rallied as investors have lost confidence in a quick resolution of the U.S. housing slump and mortgage crisis, which are behind many of today's economic worries in both the U.S. and Europe.

But in an economic outlook released by the Fed, the central bank's policy makers said they expected U.S. economic growth to pick up as housing hits bottom and financial markets gradually resume more-normal functioning. Fed officials see the U.S. economy growing between 1.8% and 2.5% next year, according to minutes from their most recent meeting.

Who's right? History isn't much help. The stock market is notorious for predicting downturns that never materialized, while economists have failed to acknowledge some recessions until after their arrival. "Economists are extremely bad at predicting turning points, and we don't pretend to be any better," Fed Chairman Ben Bernanke told Congress earlier this month.

This time around, much depends on how tight a rein financial institutions keep on their lending and consumers keep on their spending.

By itself, the housing slump seems unlikely to choke off U.S. economic growth. Home construction accounts for less than 5% of the nation's gross domestic product. But if banks curb their lending in response to billions of dollars of mortgage-related write-offs, or if consumers cut their spending as home values fall and gasoline prices rise, it could knock the economy out of its delicate balance.

"Even if you're a dyed-in-the-wool optimist you have to say it's a more challenging time than normal," says Michael Feroli, an economist at J.P. Morgan, which cut its U.S. economic forecast last week. It now expects GDP to grow at an anemic annual rate of 0.5% this quarter and 1.5% in the first three months of 2008 -- but no recession.


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