A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.



Soft or Hard Landing?

Economists seem to be channeling a Bob Dylan refrain when it comes to forecasting the rest of the year: "It's not dark yet, but it's getting there."

The question is, just how dark will it get?

The economy has indeed slowed in recent months, most notably the decline in second-quarter GDP growth to a 2.5% annual rate from a hot 5.6% pace in the first.

The debate is now hard landing vs. soft landing, matching fears that the U.S. will lurch to recession quickly against more benign scenarios where the economy simply grows below trend for a few quarters but continues to expand.

The majority of forecasters see plenty of signs that the economy will be able to weather the current slowdown.

"It may take another month or two to know which way it's going to go," said Lakshman Achuthan, a managing director at the Economic Cycle Research Institute and one of few to correctly predict the last recession. "It's premature to say we have a soft landing. But (conditions) have not deteriorated to the extent they did (in late 2000) in front of the last recession."

Odds Of A Slump Rising

Most analysts agree risks of a recession have risen.

Economists at Merrill Lynch recently put the odds of a recession above 40%, a level that's "simply too high for comfort."

Still, most experts expect the economic cooling to remain orderly.

"We're definitely in the soft landing camp. The odds of recession seem slight. We'd need an exotic shock like an oil embargo or a terrorist attack, and I'm not even certain that would do it," said Mark Vitner, an economist at Wachovia. "The biggest risk is housing slows too much and we don't see any offsetting pickup in business investment."

Corporate earnings continue to show enduring signs of strength, spurring hope that business spending will improve despite the woes of troubled sectors like airlines and automakers.

Capital spending was weak in the second quarter after a robust start to the year. But cash-rich companies are operating near full capacity. They'll have little choice but to pick up investment in the months to come, economists said.

Firms have been preparing for a slowdown practically since the expansion started, holding the line on hiring and keeping inventories at record lows. So more-modest growth shouldn't force radical corporate upheaval.

Housing is another matter. Home sales and prices have trended lower this year, with every indication that will continue. New housing starts have fallen sharply in the face of surging inventories.

If that continues, the almighty American consumers may eventually falter as they watch their homes stop appreciating and start thinking about paying down their mortgages.

The degree to which shoppers pull back will be the biggest factor in how much U.S. growth slows.

Achuthan said while a meaningful consumer slowdown remains a real risk, leading indicators for the service sector -- a big chunk of consumer spending -- have shown some recent signs of resilience.

Still, worries over a hard landing -- where the economy lurches from expansion directly to recession -- are justified.

While the Fed managed to squash inflation in 1994-95 without killing the expansion -- setting the stage for the late '90s economic and stock market boom -- policymakers typically end up slamming the brakes too hard.

Luckily, America's hard landings have softened in recent decades. Whether it's due to sound Fed policy, better business planning or just dumb luck, the U.S. faced mild, short-lived recessions in 1990-1991 and 2001 between long expansions.

Still, even if the heart of the U.S. economy remains strong, pressures have weakened its immune system.

Shocks like Hurricane Katrina or a spike in oil prices that the U.S. absorbed a year ago would cause more damage today, some experts say.

Investors also continue to stare down a separate but equally important worry: inflation.

The Fed's Aug. 8 decision to pause its two-year rate hike campaign showed central bankers -- with one dissenting member -- expect their 17 rate increases will rein in inflation without triggering a recession.

However, two senior Fed officials on Tuesday stressed inflation risks.

The Fed's move to stand pat will have little impact compared with the hikes it's already pushed through. Like most analysts, the Fed is in wait-and-see mode, trying to gauge what will happen with housing activity, consumer spending and oil prices, along with overseas growth and a host of other factors.

Thursday's report on July durable goods offers the latest look at demand for big-ticket items among businesses and consumers.