Hello, Recession

10/15/2008 10:50 am EST


David Wyss

Adjunct Professor, Brown University

David Wyss, chief economist of Standard & Poor’s, says the coming recession will be moderate, but the financial crisis is a big wildcard.

The incoming data make it hard to deny that we are in recession. Payrolls have now dropped for nine consecutive months, and the unemployment rate is up to 6.1%, from 4.4% in March 2007. Although real gross domestic product (GDP) growth is likely to remain slightly positive in the third quarter, the fourth quarter and the first half of 2009 are looking very weak.

The coming recession now looks more like a moderate than a mild downturn, with real GDP expected to drop 0.9% from peak to trough. On the positive side, oil prices are back under $90 a barrel, down from their $148 peak in July. The lower oil prices will relieve some of the squeeze on consumers. But declining house and stock prices are cutting wealth, most Americans have already spent their rebate checks, and the unemployment rate is rising. The bottom line: the consumer will have to cut back.

The financial turmoil and economic weakness have increased the pressure on the Federal Reserve to lower rates. The half-point rate cut coordinated among many of the world’s central banks, led by the Federal Reserve and European Central Bank (ECB), have done little thus far to free up credit markets or improve the mood of the stock market.

Another rate cut is likely by year-end, taking the fed funds rate down to its 2003 low of 1%. The weak European economy may also require further stimulus and another ECB rate cut is likely.

This is the most severe global panic since the Depression. Most other recent disruptions—the Asian currency crisis, the US savings and loan crisis, the Japanese property bubble, and various Latin American problems—only affected individual countries or regions. The global nature of the current turbulence makes it harder to forecast its duration, because solving the problem will require cooperation among the world’s financial authorities.

The dollar has benefited from the turmoil, as investors flock to US government assets as the safest haven. The dollar has now recovered all of its losses of the previous year, [while] short-term US Treasury yields have plunged to their lowest level since Word War II, with the three-month bill yielding only 0.6% (and briefly turning negative).

S&P expects the dollar to remain in a trading range for a while, but once the turmoil calms and the need for safety diminishes, the dollar will slide again and likely put pressure on bond yields, pushing long-term rates up in the United States.

With the dollar stronger and foreign economies weakening, improvement in the trade deficit—at least the non-oil deficit—should slow. We still expect some progress, but it probably won’t be as spectacular as it was over the last year.

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