Signs Are Pointing South on Wall St.

Bond Yields Fall
SOURCE: Bloomberg News | The Washington Post - November 27, 2007
By Neil Irwin
Washington Post Staff Writer
Tuesday, November 27, 2007

Wall Street is betting on a recession.

Investors in stocks and bonds are paying prices that indicate they believe a snowballing housing crisis and worsening credit crunch will soon tip the U.S. economy into a recession, analysts said. Many economists, including leaders of the Federal Reserve, don't think things will get that bad, but some say the risk of a serious downturn has risen in recent weeks.

Investors were so eager to buy ultra-safe government bonds yesterday that they were willing to accept sharply lower interest rates. The rate on the 10-year Treasury bond fell to 3.84 percent from 4 percent Friday. The low rates indicate investors expect the Federal Reserve to cut interest rates aggressively in the coming year to ease the pain of recession.

Stocks are now down more than 10 percent from their peak in October. The Standard & Poor's 500-stock index fell 2.3 percent yesterday, dropping the market to a level that Wall Street analysts say reflects an expectation that corporate profits will fall.

Taken together, those and other data indicate that financial markets have a decidedly negative prognosis for the economy. "They're saying the odds of a recession are pretty damn high," said Diane Swonk, chief economist at Mesirow Financial.

There are reasons to think things will not get that bad, however. Holiday sales started Friday with a strong 8.3 percent gain over last year, and U.S. consumers have proven resilient in past periods of financial distress. With the dollar weakening, U.S. exporters will be at an advantage; joblessness remains near historic lows, at 4.7 percent; and the stock market, an old joke goes, has predicted nine of the past five recessions.

Moreover, economic growth could slow sharply through the first half of next year, as the Federal Reserve and myriad private firms predict, without technically falling into recession territory. A recession is defined as a significant decline in economic activity, as measured by a variety of indicators, that lasts more than a few months. The nonprofit Conference Board said yesterday that its index of leading economic indicators fell in October, but not by so much as to suggest a recession is about to begin.

Other events yesterday showed how widely worry has spread.

The Federal Reserve Bank of New York said it would make at least $8 billion available so banks do not find themselves short of cash through early January. Former Treasury secretary Lawrence Summers said in a column in yesterday's Financial Times that he now believes the odds favor a recession, a view he did not hold a few weeks ago.

Housing prices are falling sharply in many of the nation's biggest cities, and millions of foreclosures are forecast for the next two years. Oil prices are near $100 per barrel, which could thin out consumers' pocketbooks if the winter is especially cold. And as the value of the dollar drops, imports as varied as French wine and Japanese electronics could become more expensive.

In a view increasingly typical among Wall Street economists, analysts at Merrill Lynch published a research note yesterday with the headline: "We believe we are going to see a recession in '08."

Widespread expectations of a recession could be self-fulfilling because of how financial markets and mainstream America are interconnected. If investors are sufficiently convinced a recession is ahead, they would be reluctant to lend money to businesses that want to expand, making it so.

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