Signs of faltering US economy surface

When the Fed convenes Tuesday, it could signal how it might respond to the slowdown.

from the August 6, 2007 edition

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But economists are not so sure the consumer has the income to keep going to the mall. The latest employment and hours-worked numbers indicate only ho-hum gains in income, says John Silvia, chief economist at Wachovia Corporation in Charlotte, N.C. "Consumer income is not doing very much," he says. "The consumer side of the economy is OK, but just OK."

When the Fed meets Tuesday the central bankers will also be discussing the inflation rate. In June, the headline inflation rate was up 0.4 percent but the core rate – the inflation rate without energy or food inflation, was up 0.2 percent.

As of June, the Consumer Price Index was up 2.7 percent on a year-over-year basis.

"If you include food and energy – and I think it's legitimate to include it if it rises every month – then inflation is of some concern to the Fed," says Kasriel.

Dollar signs

The Fed has also indicated it is keeping an eye on the dollar since the sliding greenback could result in a higher inflation rate.

"Every time there is a hint the Fed will ease, the dollar gives way," Kasriel adds. "The Fed does not care where the dollar is, but does care whether the weaker dollar will generate higher inflation in the US."

Problems in the financial markets, for many economists, are the most worrisome signs for the economy. Last week, American Home Mortgage of Melville, N.Y., said it would lay off 6,000 employees and stop taking applications for mortgages.

Then, on Friday, a credit rating agency downgraded the debt of Bear Stearns, an important Wall Street investment bank. In recent weeks, the company has had to close several funds that invested in subprime mortgages, loans made to people with marginal credit scores.

After the downgrade of Bear Stearns, the stock market fell sharply with the Dow Jones Industrial Average closing with a 281 point drop. Some economists wondered if the Fed would have to reassure investors as much as it did in 1998 and 1987 after stock market shocks.

A silver lining?

The corporate debt market, however, started to show some signs of life. Last week, for example, Cerberus Management was able to borrow about $10 billion for its purchase of Chrysler. Despite the transaction, Andrew Cole, director of Asset Management Allocation at Baring Asset Management in London, wrote clients Friday to tell them it could take several weeks, if not some months, for the system to get back to normal.

However, Mr. Cole added that "despite the recent spasm in the credit markets, there is no reason yet to expect a credit crunch."

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