Economy’s Fate in Fed’s Hands, PCA Economist Warns
Further interest rate cuts by the Federal Reserve Board are needed to avert a full-fledged economic recession as the subprime mortgage crisis continues to raise doubts about U.S. levels of consumption and investment next year, according to Ed Sullivan, chief economist for the Portland Cement Association (PCA).
Even without an economic downturn, Sullivan told PCA board members in late October that the cement industry is facing further declines this year and next, largely because of adverse conditions in the housing industry but also on account of growing weakness in nonresidential construction, which is expected to decline in 2008.
“From a planning perspective, it seems that with this amount of risk out there right now, it is prudent to take a very conservative approach to near-term strategic planning,” Sullivan said.
PCA’s current baseline forecast is calling for a 7% decline in cement consumption this year, he said, followed by a 2.5% drop in 2008, a return to 2007 levels in 2009 and stronger growth in 2010 and 2011.
The housing market, according to the PCA forecast, is not expected to rebound until mid-2009 as it struggles to work down excessive inventories, an effort made more difficult by tighter mortgage lending standards and high levels of foreclosures through 2008 but helped by improved affordability in high-cost markets where prices are moderating and mortgage rates are remaining at favorable levels.
Adding to the housing inventory, foreclosures are expected to total 1.2 million this year, he said, up from 400,000 in 2006.
Although nonresidential construction has risen by 17% this year, partially offsetting the decline in demand for cement from home builders, that sector is now expected to experience a “modest” 2.5% decline in 2008, he said, as the tighter credit conditions dampening residential mortgages expand to commercial markets and risk premiums are increased.
“The subprime issue has bled through to other sectors of the economy and will have a long period of adjustment,” Sullivan said.
If job growth weakens substantially, he added, states could begin to see declining tax revenues, which in turn could lead to a serious slowdown in public construction projects in 2009. The PCA forecast projects an average of 50,000 new jobs per month next year, down from 100,000 in its previous forecast.
Sullivan acknowledged that the fundamentals for the U.S. economy remain strong even as it becomes apparent that growth will be slowing substantially, and he pegged the chances of a 2008 recession in the 35% to 40% range.
Under the most likely scenario for the economy, growth of the gross domestic product will slip to a 1% rate by the first quarter of next year but average 1.8% for the entire year, a tad below the 2% rate projected for all of 2007.
“This assumes that the Federal Reserve can correctly assess issues that lie ahead for the economy,” Sullivan said, with further cuts in interest rates through early 2008.
“We don’t believe that a recession can occur unless the Federal Reserve miscalculates,” he said.
If the Fed is hesitant or becomes distracted by energy costs, inflationary pressures or a flurry of consumer spending, it could find itself having to act belatedly next year, when it will be “too late” to save the economy, Sullivan warned.
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