Recession fears will be reinforced by next Friday's employment report

Next Friday's release of the March Employment report is likely to heighten market fears of a deepening recession. Expect a further decline in overall nonfarm payrolls, especially in manufacturing payrolls, and a rise in the unemployment rate to at least 4.9% and more likely 5.0%, reversing February's aberrant decline to 4.8%. That dismal employment report, capping other signs of economic contraction next week, will reinforce prospects for a decrease in first quarter GDP to be reported at the end of April, marking the onset of recession. Tuesday, look for an additional decline in the March Institute of Supply Management manufacturing index (from the 5-year low of 48.3 reported for February). Also Tuesday, February construction spending will likely extend the January plunge, the steepest in fourteen years. In response to such bleak reports, there is likely to be additional weakness in the equity market and a continuation of low Treasury yields.

The markets will grow increasingly confident of a further Fed easing in April to 1.75%, or at least 2.0%, from the current 2.25%. Despite the Fed's agressive easing to date and other Fed and US Treasury measures to add liquidity to the financial system, the problems persist.

Financial system losses, capital charge-offs and write-downs continue to mount. Estimates of losses thus far recognized by bank and non-bank lenders and investors are now in the area of $500 billion. But, the risk is that there are more losses still to be recognized and more charge-offs of capital to come. Even if that were not the case, the massive contraction of bank and non-bank capital already realized needs to be replenished by the financial system and the loss of lender confidence restored before the pronounced credit squeeze is reversed. Because bank and non-bank lending is leveraged on a capital base, the capital contraction forces a credit deleveraging that can be a 10-times multiple of the capital losses. That adds up to a monumental credit contraction problem.

The forced sale of Bear Stearns was not the end of the problem. That measure was necessary to protect Bear Stearns counter-parties from triggering a massive cascading credit crisis. Though the situation may appear less dire for the moment, appearances can be decieving.

Underlying problems persist, including unpricable illiquid sub-prime mortgage-related assets, much of it hidden off the balance sheet. Home prices continue to decline, while mortgage interest rate resets, delinquencies, defaults and foreclosures continue on the upswing. A construction and housing related credit bust is far more worrisome as an economic depressant than merely a decline in the equity market. The IMF concluded on the basis of a survey of the business cycles of 21 industrial countries that a recession precipitated by a housing contraction is twice as deep as one reflecting principally an equity market decline. This recession is likely to be reinforced in its contraction by a further decline not only in housing, commercial real estate and equities, but also a global recession, a 20% or larger decline in most basic commodity prices (reversing speculative buying), a contraction in consumer spending and more cautious business capital spending.

This recession is unfolding in slow motion. But, do not be decieved by its gradual nature into assuming that the worst is over, that it will be mild or its duration brief.

Philip Braverman, President
Braverman Economic Consulting
One Hewitt Square #249
East Northport, New York 11731