Coming in for a landing

The combination of aggressive Federal Reserve rate cuts and Washington’s fiscal stimulus would suggest officials believe a recession has begun, even though in the middle of January, Fed Chairman Ben Bernanke assured Congress a recession was not the Fed’s base forecast. The media also seems to be playing up the recession story.

Although a recession might seem like a forgone conclusion, it is not — no matter how loud the talking heads on TV scream about it or how many times the press flaunts the “R” word. In fact, because of the lack of an agreed-upon definition of recession in real time, it may be more fruitful to think about what kind of landing is in store for the U.S. economy: Will it be short and shallow or long and deep?

The case for a long and deep downturn is clear. Although there certainly were observers who had been playing.

Subsequently other data has pointed to a hard landing. There is the evidence, including the Fed’s own survey of senior lending officers, of tightening credit conditions. Through December, leading economic indicators declined for three consecutive months (another recession rule of thumb). The wealth effect of falling equities — by Jan. 22 nearly $2 trillion of market capitalization disappeared since the start of the year — and falling home prices are additional shocks to the system.

Of course, these developments are following the series of negative shocks that include the rise in oil, gasoline, and heating oil prices. The housing market remains depressed. Corporate profits have been crushed and financial intermediaries have reported more than $100 billion in write-downs, losses, and loan-loss reserves. Through Jan. 24 the S&P 500 companies that have reported Q4 earnings had a 45-percent average drop in profits.

Greenspan has opined the risks of a U.S. recession have increased to better than 50 percent, but there is a reason why he told the Financial Times that “the hard data that we are in a recession is by no means conclusive.”

For instance, an accumulation of excess inventories, which often proceeds an economic downturn, does not seem present now. Automakers dramatically reduced inventories in the fourth quarter and this would seem to minimize the need to cut production in Q1 2008. Overall business inventories are relatively low compared to sales; the inventory-tosales ratio is at the lower end of a multi-year range.

Weekly initial jobless claims have been much lower than one would expect if the U.S. economy were contracting. In fact, the strength of this admittedly noisy data series suggests U.S. job growth rebounded in January. Also, job growth could be four times greater than the 18,000 reported in December, which is subject to revisions. A net rise of around 100k in non-farm payrolls would single handily take the recession talk down a notch or two. That said, job losses in the construction, credit intermediation, and real estate sectors are poised to continue.

Noted economist Martin Feldstein, who heads the NBER, has long warned that the U.S. was likely headed for a recession. He had been an early advocate of a fiscal stimulus plan. However, he argued that although a plan should be drawn up, it should not be implemented until private sector jobs fell three consecutive months. Private sector payrolls fell in December for the first time since mid-2003. A job-growth rise would also suggest hard landing talk may be a bit ahead of itself.