NEW YORK, DEC. 9 -- The U.S. economy will dodge a recession in 1988 but will experience higher interest rates, heightened inflation and volatile financial markets, according to a leading Wall Street economist.
Henry Kaufman, managing director at the large investment firm Salomon Inc., also predicted in his annual report on the world economic and financial outlook that the "element of crisis" present in global markets during October of this year will likely emerge again during 1988.
Kaufman has become known in recent years in part for his pessimistic views about the economy, which have earned him the moniker "Dr. Gloom."
He said that a "brisk revival" of U.S. economic activity next year will increase inflation, forcing the Federal Reserve to push up interest rates while tightening credit.
He predicted the U.S. economy would expand at a 2.7 percent annual rate between the fourth quarter of this year and the fourth quarter of 1988, spurred by a large expected gain in U.S. export volume.
But Kaufman said that next year's growth will mark the last phase of the current U.S. expansion and will likely be followed by recession in 1989. "It is much too early to speculate about the magnitude of a recession," Kaufman said.
The Salomon report forecasts the annual inflation rate during 1988 at 5.2 percent, rising from an expected 4.6 percent in 1987 and reaching an annual 6.2 percent rate in the fourth quarter of next year. Salomon projects yields on long-term U.S. Treasury bonds will reach 11 percent or higher, perhaps as early as summer.
Kaufman's scenario depends on his assessment that the U.S. economy will recover from a period of sluggishness extending from late this year into early 1988. Other economists have forecast lower growth than Kaufman; some have recently predicted a recession next year. The Salomon economist's influence over the financial markets has waned in recent years because some of his past forecasts have not proved accurate.
At a briefing here, Kaufman conceded that there were risks that his analysis was based on faulty assumptions, but he indicated that, if anything, he expects economic recovery in the United States to be stronger than he has forecast. He also cautioned that the volatility he expects in financial markets could alter dramatically the expectations of investors and shift the economy's course.
The recovery Kaufman predicted would increase inflationary pressures, force a tightening of credit and lead to "reluctant support" of the dollar by Europe and Japan.
These conflicting pressures, combined with what Kaufman sees as increasing policy disagreements between the United States and its major economic allies, will contribute to a pattern of "lurches" in the world's financial markets, according to the report.
U.S. dependence on foreign lending and investment should persist at record levels next year, Kaufman said, despite a relative slowdown in domestic borrowing demands.
For investors, the Salomon report recommends stocks of U.S. companies that are likely to benefit from a steadily declining dollar next year. Such companies would include those whose earnings depend on exports.
Robert S. Salomon Jr., the firm's director of stock research, said at today's briefing that he expects stock prices around the world to rise between 15 and 20 percent during the next three to six months, buoyed by better-than-expected corporate earnings.
Government securities markets in Europe are expected to outperform U.S. fixed income markets in 1988, according to the report. Salomon recommends bonds denominated in French francs and German marks.
Overall, the report recommends that investors stay alert during the coming year and be prepared to shift between investments.
"It is recommended that investors who hold U.S. dollar-denominated assets maintain very short portfolio durations during most of 1988 because of the expected general direction of interest rates and the anticipated periods of extreme market turbulence," the report said.