January 4, 2008 / 10:23 PM / 12 years ago

U.S. may avoid recession but prospects dwindling

WASHINGTON (Reuters) - A bleak U.S. employment picture in December and a decline in factory activity have led many analysts to conclude there is only a slim chance the United States steers clear of recession.

While it could happen, the thinking on Wall Street is that a recession cannot be avoided without serious help from the Federal Reserve and only if troubles in the housing and credit markets have bottomed out.

But the Fed may find itself between a rock and a hard place, with dueling mandates to promote growth and keep inflation at bay. At the same time, the credit crisis could simply roll on throughout the year as more funds and firms announce write-offs associated with failing home loans.

Bruce Kasman, chief economist at JPMorgan, the nation’s third-largest bank, puts the odds of a recession at 40 percent, but worries the risk may be higher. “I’m not sitting here with enormous conviction,” he said.

The economy added just 18,000 jobs last month, kept aloft by government hiring. Private sector payrolls shrank for the first time in nearly 4-1/2 years, the Labor Department said on Friday. In addition, the unemployment rate climbed to its highest level in more than two years.

The dour jobs figures added to a dim outlook painted by another report this week from the Institute for Supply Management that showed factory activity shrank in December for the first time in nearly a year.

“The whole first half of this year looks very bad,” said Nigel Gault, U.S. economist at Global Insight in Lexington, Mass. He said that with a deteriorating jobs picture, consumer spending — which fuels roughly two-thirds of the economy — could falter.

“There are just so many things hitting the consumer, sagging home prices, higher energy prices and now we’ve got weaker job growth,” Gault said.

LOOKING TO THE FED

For Wall Street, the cure seems simple: more Fed interest rate cuts.

December’s slim jobs growth led some Wall Street firms to abandon forecasts for a modest quarter-percentage-point rate cut when policy-makers meet later this month and place their bets on a bolder half-point move.

The chances of a half-point reduction, as implied by prices on interest rate futures contracts, shot up to nearly 70 percent on Friday from around 30 percent on Thursday.

“The Fed is definitely cutting rates and this may actually encourage them to do more,” Joseph Lavorgna, chief U.S. economist at Deutsche Bank Securities in New York, said of the jobs report.

The central bank’s policy-setting committee meets on January 29-30. It already has cut its benchmark federal funds rate 1 full percentage point since mid-September as credit market turmoil unfolded.

INFLATION STILL A THREAT

But outside of Wall Street, economists caution that inflation remains in the picture and cannot be ignored. This, they say, makes the Fed’s task all the more difficult.

“My view is that we at the moment have stagflation,” said Allen Sinai, at Decision Economics in Boston. “We have very anemic growth ... and we may even have a full-fledged recession, but we do have a dose of higher inflation coming from energy, food and healthcare.”

Gauges of core inflation, which strip out food and energy prices, have crept above 2 percent, outside of the inflationary “comfort zone” cited by many Fed officials. In addition, oil prices topped $100 a barrel this week and the ISM factory report showed manufacturing price pressures on the rise.

“This puts the Fed into a quandary: Which master to serve? The economic growth master or the stable prices master?” said Ken Mayland, an economist who runs ClearView Economics in the Cleveland area.

Still, economists think given the severity of the economy’s health right now, it is more likely the central bank will cut rates to help boost growth.

“It’s about triage here. I think the Fed understands that the damage that would be done by allowing a recession to take hold is a more immediate threat,” said JPMorgan’s Kasman.

Reporting By Joanne Morrison; Editing by Dan Grebler

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