The recession will be deep or protracted and perhaps both

The recession promises to be far worse than is widely anticipated. Because the economic downturn thus far appears to be primarily financial and related to housing, it has deceived many observers into believing it will be both shallow and brief. These observers are reinforced in their mistaken view by overconfidence in the effectiveness of Fed easing, fiscal stimulus and belated regulatory measures to both stem the recession and restore confidence. My pessimism is related to the very nature and broad scope of the credit problem. What many observers fail to adequately realize is the profound credit crunch that is already underway and the central role that the consequent reduced availability of credit will have in constraining spending throughout the economy. It is credit flows and credit availability that is the prime determinant of economic activity.



And it is not because I believe the Fed is about to turn cautious in its easing pace. Indeed, I expect the Fed to cut the Federal funds rate to at least 3.0% in March, to 2.0% by year end and to 1.0% next year, matching their previous cyclical low. However, that easing process will not quickly reverse the capital writedowns and chargeoffs that banks and other lenders and insurance companies are being forced to take. And there are more losses on loans and other obligations still to be recognized, with further consequent capital erosions. As long as current capital requirements are in place, without additional capital infusions. banks and other lenders may not be able to maintain their current loan portfolio. How then can they add to loan portfolios. That capital problem will in turn constrain lending and reduce spending by virtually all the economy's sectors, including the consumer, business, and state and local governments.



The consumer had repeatedly refinanced their mortgages, thereby using the equity in their homes to spend more than they earned in recent years. That foolish practice is at an end. But consumers are now running up credit card debts on which they will increasingly default.



Business will be far more concerned with shoring up their balance sheets than spending on capital investment or expansion. Increasing excess capacity will, for the most part, make such expansion unnecessary. Moreover, the sharply widening corporate quality yield-spread is a costly disincentive to borrow.



State and local governments will face worsening deficits and as a result increased borrowing needs. Their dependence on insurance company guarantees for much of that borrowing is compromised by the heavy losses those companies have taken on guarantees on non-municipal debt obligations. If those insurance companies split in two (as proposed by NY Governor Spitzer), in order to be able to maintain their AAA rating and insure new municial bonds, there would be other problems. The part of the insurance company left with all the losses would likely throw those losses back on the banks, forcing still more capital losses and loan constraints. If instead, the banks shore up the insurance companies, bank capital will be employed that cannot be used to support other lending.



These are not domestic problems alone. A global recession is looming. Expect more rate cuts by the Bank of England and eventually by the European Central Bank. And Asia will not be immune. The recession will diminish inflation, including declines in commodity prices, which may not reach their lows until 2010. Corporate profits are likely to be dissapointing, leading to further declines in equity prices. Expect new lows in US Treasury yields throughout the maturity yield spectrum. Stay tuned for weekly updates.















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The rise in Treasury bond yields will be reversed

The backup in Treasury bond yields in recent weeks will be followed by a renewed yield decline, almost certainly to new cyclical note and bond yield lows. That was the Treasury yield pattern in previous periods of Fed easing. And there is every reason to expect a repetition of that experience in this recession as well. For example, in early 2001, the 10-year Treasury note yield rose one half percentage point, after having fallen more than one and a half percentage points from its late 1999 yield peak. But within a few months after the early 2001 yield back-up, as the Fed continued easing, Treasury 10-year note yields reached new lows. There was further yield volitility in that cycle. But, each subsequent yield back-up was also followed by a new still lower cyclical Treasury yield low. The ulitmate cyclical Treasury yield low was not reached until mid May 2003. That irregular Treasury yield pattern duplicates the cyclical experience in earlier periods of Fed easing as well, with yield back-ups followed by new yield lows. Indeed, it is instructive that the cyclical decline in 10-year Treasury yields, peak to trough, in the three prior periods of Fed easing (1989-1992, 1995-1998, 2000-2003), extended for over three years. With that time-table, the current cyclical decline in Treasury yields is less than half over. One can speculate as to the reason for this pattern. The bond market is confronted by still worrisome inflation indicators in the current and comparable stages of prior recessions. However, as the recession becomes deeper and more widespread, the credit markets inflation fears will be quelled. That in turn will reduce the inflation component of Treasury bond yields. That subdued inflation experience typically prevails even in the early stages of economic expansion amidst significant excess capacity and rapid productivity gains.

The economic and financial market outlook for the US is gloomy.

The economic and financial market outlook for the US is gloomy. A recession not only seems inevitable, the evidence suggests a cyclical economic downturn has most likely already begun.The number of economic sectors involved in the economic contraction is rapidly broadening. This past week the widely respected Institute of Supply Management non-manufacturing index, an indication of the US services sector, declined very sharply in January to not only the lowest level since October 2001 but to a recessionary level. This augments the significant contraction already underway in manufacturing and just the latest report adding to the evidence of recession. Perhaps the most telling aspect of the January employment report was the largely overlooked aggregate hours worked, which indicates a probable decline in first quarter 2008 real GDP. This should come as no surprise with the widening credit crunch affecting not only real estate, but finance, business, state and local governments and consumers. The state of consumer finances appears to be rapidly deteriorating judging by the rising rate of credit card delinquencies and defaults as well as home mortgage foreclosures. A further indication of the strained state of consumer finances was embodied in the Wal-Mart explanation for missing its performance targets. Wal-Mart noted that its customers were spending their gift cards on food rather than on discretionary consumers goods. The hesitancy of most economists to adequately recognize the developing recession typically rests on the thus far only moderate declines in employment, as well as the strength of inflation and the global economy. But, this misses the lagging nature of these variables. As the recession unfolds, employment will worsen, the global economy will slow, eventually dampening inflation. These prospects will not be prevented by continuing Fed easing and the fiscal stimulus. The corporate profit picture will darken materially, leading to further declines in equity prices. Stay tuned for further comments. Phil Braverman

Philip Braverman, President of Braverman Consulting has had a long and distinguished career on Wall Street. He was Chief Economist of Chase Manhattan Bank Securities, Chief Economist and Executive Director of Irving Bank Securities and Bank of New York Securities and was most recently Chief Economist of DKB Securities, now part of the Mizuho Group. In assessing Mr. Braverman's performance as an interest rate forecaster and that of other so called interest rate gurus, Financial World called him "the best of the lot." Barron's characterized his forecasting track record as "uncannily accurate." The Wall Street Journal referred to him as an accurate foreign exchange forecaster and Telerate said "he has for long correctly predicted interest rates and Fed moves."