US recession risk is real

The US economy continues to suffer from a battered housing market and consumer credit crunch. These events have shaken financial markets and sparked fears of recession in 2008.

US economic data has displayed alternating weak and strong tendencies for months, generating considerable uncertainty about the direction of the economy. After slowing in the first half of 2007, the economy posted surprisingly strong 4.9% GDP growth in the third quarter. Consumer spending increased by a moderate 2.7% annualised rate, while US exports surged at an 18.9% rate to help drive forward the expansion.

Several key factors stand out among these mixed indicators:

Healthy export performance almost certainly was boosted by the sharply weaker dollar, which fell to record lows against several major currencies.
Capital spending for equipment and software increased by a solid 7.2% in the third quarter.
Labour markets have been steady, with employers creating 94,000 net new jobs in November and 170,000 in October.
Closely watched initial unemployment claims have drifted upward in recent months, but are nowhere near the surging levels that would presage a recession.
However, a wide range of monthly indicators, including industrial production, orders for capital goods, building permits for new housing, and retail sales have shown weakness.

Private sector economists on average anticipate GDP growth of approximately 1.9% in 2008 -- the same as the latest IMF forecast. The range of individual forecasts by Federal Reserve governors and regional bank presidents -- just starting to be published as part of Fed Chairman Ben Bernanke's new openness policy -- was 1.6-2.6%, or 2.1% on average. Yet a number of prominent economists, including former Treasury Secretary Lawrence Summers, have argued that the odds of a recession are closer to "50-50".

If a recession develops in 2008, the impact of the decline in housing prices on consumer spending and access to credit will be responsible. MEW is now in a reversal phase and likely substantially to weaken consumption spending. This suggests that growth will under-perform relative to the trend rate of 3% per year, as the economy enters an adjustment phase. A full-fledged recession cannot be ruled out.