Economic engine likely to downshift

Experts see a US economy that is no longer revving, but better than sluggish.

For the past 2-1/2 years, economists have been seeing a phantom: an economic slowdown, which never seems to materialize.

For next year, they're making the same prediction: The US economy will be struggling to maintain its resilience. Corporations will see profits shrink, and consumers will moderate their spending. If the phantom becomes reality, the Federal Reserve will continue to lower interest rates.

"If it weren't for the consumer, we would already be in a recession," says Scott Grannis, chief economist for Western Asset, a Pasadena, Calif., money manager.

The pessimistic economists use words like caution or worrisome. Their concern is that the rest of the world will finally drag down the US economy. Add a potential stockmarket downturn and they predict American consumers will become more cautious.

Even the most optimistic economists describe the economy as slowing to a more "normal" pace, that is a moderate rate of growth that can be sustained. They think the momentum from this year will carry over to the next. And after underestimating the economy for the past two years, they have learned their lesson. "I am revising my growth forecasts a little higher," says Larry Kreicher, chief economist for Alliance Capital, which runs $240 billion in assets.

The reason for the uncertainty in the forecast is that the economy at year's end is still rambunctious. Retailers report consumers are still hitting the malls and department stores. Capital-goods spending is expected to bounce back after falling last quarter. The stock market - a barometer to some extent - is bringing smiles to Wall Street as the Dow Jones Industrial Average remains above the 9000 level. Economists now expect the fourth quarter gross domestic product (GDP) will show the economy moving at a brisk 3.5 percent to 4 percent annual rate.

But few expect the economy will continue to grow at this pace. The conventional wisdom calls for consumers to finally stop spending beyond their income growth.

And there are some signs that consumer confidence is eroding as corporate layoffs begin to spread. "Even modest increases in concerns about future job prospects will slow the pace of spending during 1999," says Richard Curtin, director of the University of Michigan's Surveys of Consumers.

If consumers do stop spending so liberally, economists expect the GDP will grow at about a 2.5 percent annual rate in the first half, before slowing further in the second half of the year. Forecasters do not agree on how much the economy will slow. Optimists call for a steady 2 percent growth at year's end. Pessimists foresee 1.5 percent or less.

Whither interest rates

With expectations that the economy will slow, almost all economists expect the Federal Reserve to continue to cut interest rates. Optimists expect the next rate cut will be in the spring, once the Fed sees concrete evidence the economy is slowing.

"The Fed would like to do as much as it can to contribute to [alleviating] the global economic crisis," says Lyle Gramley, a consulting economist at the Mortgage Bankers Association and a former Fed governor. "It will take the opportunity to lower rates if that doesn't threaten to push up inflation."

More pessimistic economists say the Fed will have to act a lot more often and sooner. Mr. Grannis argues that monetary policy is far too tight given the low inflation rate.

"Inflation risks are declining, not rising," he says. From his perspective, the Fed could lower short-term interest rates by as much as 1-3/4 percentage points by the end of next year. This would reduce the prime interest rate - which is used in figuring rates on many credit cards - down to 6 percent from 7-3/4 percent today. The next Fed meeting is Feb. 3. "By then they will have to ease again," says Grannis.

Even if short-term rates do decline, economists don't expect long-term rates, such as mortgages, to fall much further. If rates fall the way he anticipates, Grannis projects mortgage rates would drop another 1/2 percent to 3/4 percent by the end of the year.

A bit harder for job seekers

As the economy slows, the great American jobs machine will also start to slow. But many economists don't expect to see a big uptick in unemployment. Sam Stovall, a senior investment strategist at Standard & Poor's DRI, predicts the rate will move up to 4.7 percent from its current 4.4 percent level. The level will rise as layoffs pick up. "Companies will be focusing on improving their bottom line," he says.

That bottom line will need some help, predicts Bruce Steinberg, chief economist at Merrill Lynch & Co. "The key theme in the economy will be a profit squeeze," he says. "Companies have no pricing power as they get squeezed by imports."

If corporate earnings do fall further, Sung Won Sohn, chief economist of Wells Fargo & Co., wonders how much longer the stock market can stay at current high levels.

Split on the stock market

The S&P 500 is up about 20 percent so far this year. Mr. Stovall predicts another 6 percent increase next year. However, Dr. Sohn believes there is a good case to be made that the market is overvalued.

"Federal Reserve Chairman Alan Greenspan breathed new life into the market and the economy this year, but I don't think we can count on him resuscitating it again," says Sohn, who's been predicting a sell-off.

Whether an economic downturn ever does materialize is anyone's guess. "We've been forecasting a slowdown for some time, and once again we may be wrong," says Mr. Gramley.

of 5 stories this month > Get unlimited stories
You've read 5 of 5 free stories

Only $1 for your first month.

Get unlimited Monitor journalism.