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Double Dip? A Tipping Point May Be Near

Jeff Sommer|The New York Times
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Like a car spinning its wheels, the American economy hasn’t been getting much traction. Many financial indicators are issuing worrisome signals, millions of people are still out of work, and growth is slowing.

Gregor Schuster | Photographer's Choice | Getty Images

Will the economy pick up momentum orslip back into recession? Unfortunately, the answer is very much in doubt.

“We are at a very critical moment in the business cycle,” said Lakshman Achuthan, the managing director of the , a private forecasting group with an excellent track record. After the economy began to recover last summer, in his estimation, “growth has definitely slowed.” But he said he wouldn’t have enough data until at least the fall to know “whether we’re dipping back into recession.”

Even the Federal Reserve chairman, Ben S. Bernanke, calls the current economic outlook “unusually uncertain.” And the financial markets have certainly noticed.

“The market is favoring investments thought to have no risk, like Treasuries, as opposed to assets with risk, like stocks — and that’s been becoming more and more pronounced,” said William H. Gross, co-chief investment officer of the Pacific Investment Management Company, or Pimco, the big bond manager.

In the bond market last week, safety-seeking investors bid up the prices of Treasury securities, driving down yields to extraordinarily low levels along a broad range of maturities — and extending the astonishing rally of long-term Treasury bonds, which continue to outperform the stock market and nearly every other asset class.

For the year, for example, long-term Treasuries have returned more than 15 percent, as gauged by the Barclays Capital U.S. 20+ Year Treasury Bond index. By comparison, the Standard & Poor’s 500-stock index has lost more than 2 percent, including dividends. And over the decade through July, long-term Treasuries outperformed the S.& P. 500 by more than 8.6 percentage points, annualized, according to Morningstar data.

The stock market was particularly shaky last week. On Wednesday, the Dow Jones industrial average dropped 265.42 points, or 2.5 percent, its biggest decline since June. For the week, the Dow lost more than 350 points, or 3.3 percent, closing at 10,303.15, while the S.& P. fell more than 42 points, or 3.8 percent, to 1,079.25.

This preference for bonds over stocks, which has emerged periodically since the financial crisis began in 2008, came into high relief after the Fed’s announcement on Tuesday that it would recycle the proceeds of its mortgage bond portfolio into Treasuries.

Considering the Fed balance sheet — now approximately $2.3 trillion, up from $900 billion before the financial crisis — the central bank’s latest move was modest. It will translate into $200 million to $400 million in purchases of Treasuries over 12 months, according to an estimate by Bank of America Merrill Lynch. But it was the direction the Fed was taking — its decision to maintain an expansive monetary policy through “quantitative easing,” rather than to begin monetary tightening — that was most striking.

“Ben Bernanke’s motto seems to be that he will do whatever it takes to avoid a depression and avert deflation,” said Edward Yardeni, president of Yardeni Research. “He has been very successful so far,” lowering interest rates along the yield curve and thereby stimulating the economy.

The Fed may need to go it alone over the next several months, several analysts said, because with midterm elections approaching, additional fiscal stimulus legislation may be too controversial.

Mr. Achuthan of the Economic Cycle institute said a weakening in the economy’s growth rate began to appear in the institute’s leading indicators early in the winter. “Now, that slowdown is baked in the cake, it’s already happening,” he said.

The Fed acknowledged as much last week. In a statement on Tuesday, its Open Market Committee said that the recovery pace had “slowed” and that growth “is likely to be more modest in the near term than had been anticipated.”

It’s too early to know whether the economy will tip into an actual decline, Mr. Achuthan said. The institute’s Weekly Leading Index ticked up again on Friday, after a steep plunge through late June. It’s possible that the Fed “will be able to use its influence” to engineer a soft landing and avert another, immediate recession, he said. In September or October, he said, there may be more clarity.

Mr. Gross of Pimco said the growing American trade deficit — it jumped to $49.9 billion in June, its highest level since October 2008, according to a report on Wednesday — is cutting into the G.D.P., “implying that second-quarter G.D.P. is going to be in the 1 to 2 percent range.”

In turn, he said, “that implies that the momentum of the economy from the first to the second quarter was downhill, and therefore we think “it’s quite possible that we might actually be somewhere between zero and 1 percent — in other words, very close to a double-dip recession.”

He put the probability of a recession — and of an accompanying bout of deflation — at 25 to 35 percent.

Still, the economic signs are ambiguous. After falling in the spring, industrial commodity prices have risen, suggesting that there is still surging demand from manufacturers. Shipping indexes, which had declined, have ticked upward again over the last month. Mortgage rates are dropping. And thanks in large part to fierce cost-cutting, very low interest rates, and strong demand in developing countries, corporate profits have been strong.

What’s been lacking is broad consumer demand, a revival of the housing market and sufficient business confidence in large-scale hiring. And, of course, there are deep structural economic problems — the highest ratio of public debt to gross domestic product since World War II, for example — that will need to be dealt with over many years.

Nonetheless, if there is good news in the fall — if it becomes clear that the pace of recovery has begun to accelerate — there could easily be another burst of stock market exuberance, Mr. Achuthan said. “Interest rates are very low,” he said, “and if you were to combine that with economic growth, you’ve got a wonderful recipe for profits.”

In the meantime, Mr. Gross said, with the Fed funneling money into Treasuries, the improbable rally in the bond market may still have a way to go.

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