Uncertainty and housing.
Those are the key words in forecasts of the US economy in 2008.
And just how bad the economy performs depends mostly on the depth and duration of the housing recession and the great unknowns of the credit crunch.
“It’s a tough year to make forecasts,” says veteran economic forecaster Robert Brusca, chief economist Fact & Opinion Economics. “The conditions are so fluid.”
That may help explain both the great variance in forecasts from government, NGOs and private firms, as well as why the less recent projections look so out of whack.
The most optimistic GDP forecasts come from the White House (2.7 percent) and the Congressional Budget Office (2.9 percent), which was made in July.
The most hedged – unsurprisingly – is the Federal Reserve's (1.8 percent –2.5 percent). Just about everyone else’s falls somewhere in between.
Outside of government, on the pessimistic side, you’ll find the International Monetary Fund (1.9 percent) and on the optimistic side, the National Association of Business Economists (2.6 percent).
Brusca is forecasting GDP of 2.25 percent in 2008, despite a weak year-on-year showing of 1.1 percent in the first quarter
A House Divided
The wild card effect of housing and credit can’t be underestimated. That’s abundantly clear in the Bush Administration forecast. In it, Treasury Secretary Henry Paulson refers to the housing and credit market as “difficulties” that will “extract a penalty from growth.”
And then some, according to David Resler, chief economist at Nomura International.
“I'm not at all confident we are close to a bottom, “ worries Resler. “It looks like housing will be a drag on the economy through most if not all of all of the year.”
Resler expects the economy to contract in the fourth quarter of 2007 and average 2.35 percent growth during 2008.
“The longer the housing contraction lasts and the bigger it is, the greater the chance it spreads to other sectors,” says Resler, adding that November’s nonfarm payroll data bears that out.
PIMCO CEO Bill Gross warns “standby for a tumultuous 2008 as the market struggles to move from the shadows back into the sunlight of sounder banking and financial management.”
Though most 2008 GDP forecasts have been lowered and there’s growing talk of recession, there’s some reason to think that the worst may be over.
The CEO Economic Outlook Index, which indicates how chief executives believe the economy will perform in the six months ahead, had a higher reading in the fourth quarter than the third quarter, reflecting a “slight rebounding of expectations.”
Christopher Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ, expects the current slowdown to continue into the first quarter of 2008, but sees upside thereafter.
“Housing has plummeted so much we must be near a bottom,” he says, betting it will be the fourth quarter. On a related note, Rupkey says, “at some point we’re going to discount the credit crunch fears.”
And for all the talk of recession, it’s more a matter of odds than foregone conclusion.
The Blue Chip Economic Indicators newsletter, which surveys some 50 top economists, placed the odds of recession in the next 12 months as one in three.
More recently CBO Director Peter Orszag told Congress on that “economic activity has probably already slowed significantly and the risk of a recession is now elevated."
Not that there are not true believers and NYU’s Nouriel Roubini is one of the more outspoken ones.
The Stern School of Business professor who runs his own consulting firm, Roubini Global Economics, is predicting an imminent recession that is both longer and deeper than those of 1991 and 2001, lasting for probably four quarters.
Roubini cites such negatives as contracting personal income, a weakening job market and high oil prices, but places special emphasis on the housing recession and a credit crunch that is “getting much worse.”
Among the unknowns are how much the housing-credit meltdown trickle affect consumer spending and job creation. What’s more, crude oil prices – forecasts for which range from $60 to $100 a barrel – may have more of an effect on an economy and consumer of diminished resilience.
“High energy prices will take a significant toll on discretionary spending” in the current quarter as well as the first quarter of 2008, warns Resler.
Jobs & The Fed's Job
In terms of the jobless rate, the White House, the Fed and CBO forecast are within two-tenths of a percent of one another, ranging from 4.7 percent to 4.9 percent, negligibly different than the November rate of 4.7 percent.
Private forecasts are hardly that optimistic, registering 5 percent or higher, and who’s right may say a lot about how low the Federal Reserve cuts interest rates.
Rupkey says a half of one percent increase in the unemployment rate from its expansionary bottom typically leads to a recession. In this case, that would mean an increase to 4.9 percent from the July low of 4.4 percent.
Labor market data were “an important part of the reason for Fed easing rather than GDP” in the last recession, adds Rupkey.
Rupkey says the notes on two- and ten-year notes have already priced in a recession and suggest the Fed could take the fed funds rate as low as three percent, although he is not predicting that.
Many private economists now say the funds rate could fall to 3.25 percent to 3.50 percent from the current 4.25 percent. Gross and Roubini say 3 percent or lower.
The overall economic slowdown does come with one bright spot —an improving inflation picture – but even that is relative.
The Fed is forecasting a range of 1.8 percent -2.1 percent for the Personal Consumption Expenditure Index, vs. 2.9-3.0 percent in 2007, while the White House expects CPI to dip from 2.3 percent to 2.1 percent. (The PCE, by the way, typically, generally reads about four-tenths of a percentage point below the CPI.)
Part of that is a result of lower demand, but a lot still depends on the price of key commodities, most notably oil and natural gas.
Resler isn’t forecasting marked improvement until the second half when CPI will average 2.2 percent.
Inflation is ”nettlesome but not terrible,” says Brusca, who is forecasting headline PCE of 2.25 percent. “That’s more inflation than you want, but you tolerate it during weak growth.”