Jamal Mecklai: Is the US going into a recession?

MARKET MANIAC

A survey of 52 economists conducted by the Blue Chip Economic Indicator showed an average forecast of 2.2% for US economic growth in 2008. A survey by Bloomberg News conducted this month had 60% of the economists surveyed thinking the US would avoid a recession, with a median growth expectation of 1.5% for the first six months of 2008. On the other hand, 40% did expect a recession this year, and economists at Goldman Sachs, Morgan Stanley, JP Morgan and Merrill Lynch are all predicting a US recession this year and have been tomtomming the need for interest rate cuts for several months.

Now, economists are famous for having a wide array of views, with most of them being wrong, but it is difficult not to notice that economists working for companies that will benefit the most from "" and, in some cases, desperately need "" lower interest rates are the ones that are screaming most loudly about how terrible things are and how the US Fed needs to cut, cut, cut rates.

The market, believing that the Fed will be driven by this hysteria, is already pricing in a 32% chance that the Fed will cut its rates by 75 basis points on January 30. Seventy-five basis points! That's huge. The Fed hasn't cut rates by that much in a single shot since 1984, when rates were over 10% in the wake of Mr Volcker's inflation-busting operation.

Now, there is little doubt that the US economy is slowing "" the economy added only 17,000 (non-farm) jobs last month, the holiday season sales have been the lowest in five years, and even the ISM (industrial production) index has fallen below the 50 level, indicating that manufacturing was contracting last month. And, of course, there is the continuing pain in the mortgage market.

On the other hand, the US is far from a basket case, which a 75 basis point rate cut would suggest. Restaurants are full everywhere; imports are rising "" the trade deficit jumped by almost 10%, to $63 bn, in January; people still seem to be buying stuff. There's been precious little talk about the recession in the presidential campaigns. And my secret weapon "" a very close friend in the US who manufactures the most wonderful embroidered pillows (and other super-discretionary stuff) "" tells me that, while he is a bit worried with all the recession talk, his business was doing just fine. Sales in 2007 were 10% higher than 2006, and, so far at least, the trade shows were looking good.

My sense is that if people are buying a hundred and fifty dollar embroidered pillows, they couldn't be hurting that bad.

In any event, dramatically lower interest rates "" there are some analysts looking for the Fed funds rate to come down to 2% (from the current 4.25%) over the next 12 to 18 months "" are not any kind of answer. The US needs to keep spending but also increase its savings rate "" rather than lower interest rates, a well-targeted fiscal stimulus seems more appropriate, as many analysts are suggesting.

Net net, I think the market's interest rate expectations are going to be dampened over the next few months. This, in turn, should give a boost to the dollar, which nearly 100% of analysts expect will decline this year. Which, of course, raises my contrarian flag "" if everybody expects US interest rates to decline sharply and the dollar to fall, why is it still at 1.47 or 1.48 to the euro?

My technical analyst and Dr Risk, my market guru, both of whom shared dollar bullishness with me over the past few months, do believe that the dollar will fall a bit in the first quarter, but recover after that, and perhaps end the year at about 1.40 to the euro. My views are stronger than that since I don't think 5 or 6% is a serious move, whereas forecasts of other currencies "" the Aussie, for example "" show a very wide range of views for end 2008, suggesting that there is a huge amount of uncertainty in the market, which portends significant change in 2008.

My belief is that the Fed will be arrested in its efforts to ease monetary policy by a quickening in inflation, which, incidentally, is already quite high "" the US PPI is at over 7% as compared with 0.1% in January this year and an average of 3% in 2006.

The US equity market will tumble further "" another 10% looks on the cards "" with the financial sector leading the way. Oil prices will remain high and sovereign funds will continue to increase their holdings in key US assets. The dollar will not fall much further "" significantly, nobody is talking about the "psychological" 1.50 level, even though it is right there "" but any decline (possibly even below 1.50) would be an excellent buying opportunity.

Gold will peak soon and the rupee "" well, since rupee strength is driven by fundamental investment interest (despite the valuations), it should remain strong, although it will only surge strongly again after the global credit crisis eases "" perhaps, by end 2008.