(cache) Gloomier Economists Say Specter Of Recession Should Mean Rate Cut

The risk of a recession is increasing, and the Federal Reserve should do something about it, according to the increasingly gloomy economists in the latest WSJ.com survey.

Fed officials have "to move to show their willingness to both avert risk of recession and stabilize the financial crisis," said Diane Swonk of Mesirow Financial. She said that Chairman Ben Bernanke's emphasis on consensus has proved to be the Fed's "weak spot in crisis mode. Now they need to show conviction instead of consensus."

Fifty of the 52 economists surveyed expect the central bank's Federal Open Market Committee to trim its target Tuesday for the federal-funds rate—the rate charged on overnight loans between banks. Only two see the Fed holding the rate steady at 4.5%, and none expects a rate increase. Some 61% say a quarter-percentage-point cut is the right move, while 27% say the Fed should cut rates by a half point. Only 12% said the Fed should stand pat.

The economists, on average, now put the chances of a recession at 38%, the highest in more than three years, and up from 33.5% in November's survey. They also reduced gross domestic product estimates across the board. Fourth-quarter growth is seen at a slim 0.9% annual rate, down from a prediction of 1.6% in the previous survey, with six economists expecting either a negative or flat reading. Three economists project an economic contraction in the first quarter of next year, with the average growth forecast at 1.5%, down from 1.9% in November.

The Fed, in weighing its move, should consider market expectations, says Stephen Stanley at RBS Greenwich Capital. The December federal-funds futures contract remained fully priced for the FOMC to cut by a quarter-percentage point, and showed about 40% odds for a half-percentage point cut. "They've already signaled a cut," he said. "They can't not ease." He and others say there are ample signs of economic weakness to justify a cut.

By nearly four to one, the economists said that the Fed, in the statement that it will issue at the close of Tuesday's meeting, should say that slow growth represents a greater risk to the economy than inflation. Such a statement would suggest further cuts may be on the way. The economists, on average, expect at least one quarter-point-cut next year.

"Bold action is needed to avoid recession," said Nicholas Perna of Perna Associates. Even Mr. Stanley, who doesn't think the Fed should explicitly say that slow growth is a greater economic risk, agrees that the slowdown is a larger concern. "Risks aren't really balanced, but they can't encourage expectations" of more cuts, he said.

Kathleen M. Camilli of Camilli Economics LLC, the most pessimistic forecaster in the survey, sees "the internal dynamics of the U.S. economy deteriorating into recession" beginning in the current quarter. "Growth will be negative this quarter, nonfarm payrolls will be revised down, and from what I can see personal consumption expenditures are rapidly slowing," she said. "All U.S. consumers, wealthy and middle-class pull back their spending when their housing investments stop appreciating, and start deteriorating in value. This is already underway, and has been exacerbated further by high oil prices."

"The economy is adjusting slowly to the housing bust," said Ram Bhagavatula of Combinatorics Capital, echoing a common theme. The average forecast for housing starts for 2008 was revised lower for the fifth consecutive month. And a projected decline in 2008 home prices -- a measured by the Office of Federal Housing Enterprise Oversight index -- steepened to a 3.5% drop from the 2.6% decrease forecast in November.

In addition, "the credit crunch is still intense and the biggest threat," said Dana Johnson at Commerica Bank. Still, the economists were lukewarm on the government's attempts to stem the subprime-mortgage problem. Just 41% said the pending Treasury-backed proposal to have lenders and servicers agree not to reset rates on certain mortgages was a welcome attempt to spare homeowners -- and the economy -- a wave of defaults and foreclosures.

Thirty-six percent of respondents said it was an unjustified effort to break deals struck between borrower and lender, and will reduce capital flowing to mortgage lending in the future. Some said it was little more than "tinkering around the edges of the housing market catastrophe," as Ian Shepherdson of High Frequency Economics put it.

Despite the middling response to the plan, Treasury Secretary Henry Paulson got support from most of the economists. Nineteen percent said he's showing leadership and bolstering confidence, while 49% said he is responding reasonably well to threats. Sixteen percent said he isn't responding strongly enough, and 16% said he's pushing for too much of a government role in the U.S. economy.

• Asked which presidential candidate would be best for the economy, only half responded but most threw their support behind Republicans. Thirty-five percent said Rudolph Giuliani would be best, while 19% chose John McCain and 15% picked Mitt Romney. Hillary Clinton got the support of 8%, while John Edwards was the only other Democrat to register with 4% of the vote. Ron Paul, Michael Bloomberg and former Alan Greenspan each got a write-in vote, despite the fact that only one of them is running.

• Most economists say the hope Europe and Asia would pick up the slack when U.S. growth faltered remains alive, with 43% firmly saying the idea is still intact and 38% saying it is too soon too tell. Just 19% said the hope is totally dead.

• Expectations for growth in nonfarm payrolls over the next month hit their lowest level since September when a dismal figure was released by the Labor Department and subsequently revised higher in October. The economy is expected to add just 83,958 jobs a month over the next year. Meanwhile, estimates for the unemployment rate in 2008 rose over 5%.