Recession? What Recession?

Source : TODAY, Thursday, January 24, 2008

The global market panic driving Tuesday’s United States Federal Reserve rate cut is rooted in the still controversial idea that the US economy has slipped into a recession.

Many market participants now take it as an article of faith that the US economy is, or will soon be, in a contractionary phase of economic activity. Some even argue that as long as it “feels” like a recession, it is one. But that sentiment obscures the reality that thus far, there is no definitive view among economists about how weak the economy is or might become.

That’s not to say anxiety is not riding high. The Fed, which cut interest rates by an unprecedented margin on Tuesday, has consistently downplayed and underestimated economic and market conditions over recent months. Clearly, policy-makers have grown more anxious.

Since September, the Fed has cut its key overnight target rate by nearly two percentage points and engineered novel mechanisms aimed at getting liquidity into financial markets. In turn, the institution’s good works have been washed away by weakening economic data, most notably on the employment and manufacturing fronts, and by a seemingly-endless stream of bad news from financial markets.

Views held by forecasters have been unusually diverse. In recent weeks, several major investment banks, including Goldman Sachs and Merrill Lynch, have officially endorsed the view that the US economy is contracting.

Merrill’s frequently-bearish chief economist David Rosenberg said the four factors watched by official business-cycle-dating body, the National Bureau of Economic Research, are each on the way down. Employment, manufacturing and retail sales, along with industrial production and income, all appear to be coming off cycle high points: Mr Rosenberg sees this as a clear sign of a recession.

What’s worse, “the healing phase involved in expunging all the excesses left over from a multi-year leveraged boom in asset values takes time,” Mr Rosenberg said. He reckons the current year will scrape by with an average growth rate of 0.8 per cent - the year will likely see three contractionary quarters - with 2009 limping by at a 1-per-cent pace.

Mr John Silvia, Wachovia Securities chief economist, sees 50-50 odds of a recession but believes if policy-makers move aggressively, a downturn need not take place.

Miller Tabak strategist Tony Crescenzi sees reasons to be hopeful. The monetary policy stance and the prospect of fiscal stimulus are reasons to believe any contraction will be short-lived. Low inventories, rising exports, healthy corporate cash positions and possible new mortgage refinancings now that rates are moving lower are other positives.

Mr Joel Naroff, who helms forecasting firm Naroff Economic Advisors, said the economic data now in hand “does not tell us we are in a recession yet”.

While he’s cautious about the outlook, he argued that Tuesday’s rate cut was forced as much by market expectations as anything else. It is entirely possible that the upcoming January jobs report may be stronger than many think, which could make the size of Tuesday’s action seem over the top, he said.

While Tuesday’s action clearly shows that Fed officials are at least mindful of worst-case outcomes, even there, one finds diversity. Mr William Poole, who will soon retire as president of the Federal Reserve in St Louis, Missouri, used his final vote as a Federal Open Market Committee member to say that the apocalypse is not now.

Mr Poole has been an unreliable guide on monetary policy, but he also represents the views of many when he argued that as bad as things are for markets, the real economy has not lost its bearings.