Economists See Recession Risk

NEW YORK CITY-A potential recession looms on the horizon. In December, the inverted yield curve on the two-year Treasury note rose above that of the 10-year note. Though the inversion does not guarantee a recession, it increases the risk of it, says Kurt Karl, chief US economist, and Arun Raha, senior economist for Swiss Re. This raises the insurer’s recession probability to 25% from 20% last month. Inverted yield curves tend to be associated with economic weakness, but there are few signs of weakness currently, they maintain.

Core inflation will remain close to 2%, forcing the Fed to raise rates to 5% by mid-year. The economy is transitioning into a slower growth phase, but inflation remains a concern. November housing starts were 2.1 million units and permit activity remained robust. But, signs of an impending slowdown are getting stronger. New home sales fell by 11.3% from October, and existing home sales also softened. The inventory of unsold homes on the market has been slowly, but steadily, increasing, they point out.

Manufacturing industrial production is up 4.1% year-over-year, the three-month moving average of orders for capital equipment–excluding defense–is up 15.8%, and housing permits are up 4%. Unemployment is falling and capacity utilization is rising, so the Fed needs to slow the economy down by raising the Fed funds rate to 5.0% by May 2006, the economist predict. Real GDP growth is likely to be 3.1% this year and 3.2% in 2007. The yield on the 10-year Treasury note will rise, but not by enough, keeping the yield curve inverted, at least in the first half of 2006. By the end of the year, however, this situation will be rectified since the 10-year yield is expected to climb above the Fed funds rate as growth accelerates, they say.