The hot topic on the Street is the probability of a recession. Robert Albertson, chief strategist at Sandler O'Neill, and this morning Angelo Mozillo, CEO of Countrywide both voiced fears that a recession was coming.
Opinions are sharply divided on this. David Bianco, UBS' Equity Strategist, said earlier this month that the S&P seems to be signaling a "financial sector recession" (i.e. that a recession is expected to mostly affect financial sector profits). However, Andrew Cates, their Economist in London, put the chances of a global recession at only 20%.
How real are the risks of recession? Those worried that it is very real point to:
1) Rise in cost of capital
2) Curtailment of credit
3) The continuing instability of U.S. home prices
Those who think the chances are small note that:
1) the global economy is strong
2) U.S. job growth remains strong, and
3) consumer spending is slowing but still strong
Right now, the majority seem to believe that the likely course is not a recession, but simply below-consensus GDP growth. Bear in mind that a recession is usually considered to be two quarters of negative GDP growth. According to Thomson, consensus for Q3 GDP is up 2.4%, though they anticipate those numbers to come down somewhat in the coming weeks. Q4 is also expected to be up 2.2%.
What could help avoid a recession? The Street is nearly unanimous on this: a firm policy response from the Fed. That's why the cut in the discount rate was an important event: traders believe the Fed will do everything they can to avoid a serious meltdown. Some argue that a recession is not a "meltdown" but part of a natural economic cycle; a credit seize-up across the board, on the other hand, is a "meltdown". Still, traders believe that a rate cut will help the credit crunch and, as a bonus, avert a recession.
In addition, there is a very interesting debate on the Street about the appropriateness of other types of intervention, ranging from allowing Fannie Mae and Freddie Mac to increase the cap on their mortgage portfolio and raising the conforming loan limit above $417,000, to a full-fledged bailout (assistance, forbearance, whatever) to homeowners who cannot pay their mortgages. Those hinting that such a move might be appropriate (which includes Bill Gross from Pimco), have argued that that their are ample precedents for such intervention, including the Resolution Trust Corporation in 1989-1990.
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