Recession Delayed, Not Denied

06/24/2008 12:00 am EST

Focus: MARKETS

David Wyss

Adjunct Professor, Brown University

David Wyss, chief economist for Standard & Poor's, says we will move into a recession early next year as consumers are buffeted by falling home value and rising gas prices.

The US economy is amazingly resilient. The housing and financial sector problems were not enough to cause a recession, despite most analysts' fears. But although the economy has been able to handle one problem-even one big problem-at a time without falling into a recession, it often falters when hit from two sides at once.

Although we think the economy has dealt with the housing problem, it can't deal with the record gasoline prices concurrently. We raised our oil price forecast to $112 per barrel for the end of next year, implying continued pressure on consumers.

We now expect the recession to be at its worst early next year. It will be a difficult recession to date because, like the 2001 downturn, the US will spend several quarters bouncing along the bottom, rather than hitting a clearly defined trough.

The stimulus package should keep the economy rising over the summer, but when the spending ends, we think the economy will slide back down. We still believe the recession will be mild, but the low isn't likely to come until early 2009, given the early rebate payments and higher oil prices, which further lowers our estimate of consumer spending over coming quarters.

Housing prices are sliding downward even more rapidly than expected. The S&P/Case-Shiller home price index was down 14.4% from a year ago (20 major metro areas) in March. With the inventory of unsold existing single-family homes at a 23-year high of 10.7 months of sales, prices are heading further south. We expect another 10% drop by this time next year.

Finding a shard of hope in the housing data takes a lot of work, but it's encouraging that sales are holding up. Also a good omen is that prices outside the Midwest and the bubble states are still relatively stable. But the correction will continue. Prices are still too high relative to income, especially in the bubble states, and the correction is probably only half over.

So far, consumer spending has been strong despite the squeeze of falling wealth and rising gasoline prices. Consumer confidence has dropped to its lowest level since the 1991 recession, according to the Conference Board, and the University of Michigan's Consumer Sentiment survey is the lowest since the 1982 downturn.

Why are consumers feeling such angst? Part of the reason is that the most visible prices are escalating the most. Prices of electronics and clothing are falling, but price changes in these categories are much less visible than food and gasoline, which households buy at least once a week. Basic foods and gasoline are also harder to postpone or substitute. These price changes are harder to avoid or ignore.

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