Economy's 'soft patch' deeper than expected

Most interest-rate observers expect the Fed will consider the second quarter to be the low-water mark for the economy, because the consumer was beset by high prices at the gas pump, the effect of the tax cuts was less than expected and mortgage refinancing slowed down.

"They have articulated that they want to move from the extreme easing of 2002 and 2003," says Scott Pedowitz, a fixed-income strategist for Commerzbank Securities in New York. "By the end of the year, the Fed funds rate will be back to 2 percent (from 1.25 percent now)," predicts Mr. Pedowitz, who anticipates the central bank will raise rates by another quarter of a percent.

Fed chairman Alan Greenspan is also probably going to start to visit car showrooms to see how well Detroit's offerings are selling. In the beginning of the second quarter, many companies had removed or reduced their incentives to buy cars. Detroit's inventories rose to 72 days, 16 percent above average.

"Americans are waiting for a better deal," says Jose Rasco, an economist at Merrill Lynch & Co. "Every time they boost incentives, Americans buy."

They won't have long to wait. In June, Edmunds.com, an online resource for auto information, reported the average incentive per vehicle reached a record $2,747, up $123 from last year and $240 over this May.

In the New York metro area, incentives ranged from 40 percent off all payments through Columbus Day at Nemet Motors in Queens to $10,000 off the list price for an Eddie Bauer Ford Expedition at Wantagh Ford in Wantagh, N.Y.

Those temptations are essential, says Richard Curtin, director of the University of Michigan's Survey of Consumers. On Friday, the University released its latest survey which showed consumers optimistic about almost everything but buying a new vehicle.

"I think it's largely because consumers had thought gas prices would go down rapidly, but now they have concluded they are going to stay at this level for a good long time and it's affecting their decisions," says Mr. Curtin.

Moving the cars will be essential, not just for the economy, but also for President Bush. Many cars and auto parts are built in Ohio, Michigan, West Virginia, and Pennsylvania. "It would not be a good thing to have rising layoffs in a swing state," says Curtin.

One of the key areas that may determine whether consumers return to the lots will be the price of gasoline.

Last week, the price spiked up sharply on concerns that the Russian oil company Yukos would not be allowed to export oil because of a tax dispute it's having with the government. "Rising energy prices are the key risk to the economy and the president's reelection," says Mr. Zandi. "If energy prices spike, people will feel it and it will play out politically."

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