From the October 2007 issue of Investment Advisor • Subscribe!

October 1, 2007

How the Credit Crunch Might Slow the Economy

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Could the current credit and markets crisis affect the economy? All eyes were on the Fed as we went to press and what it would do, or not do, with rates on September 18.

Chief U.S. Economist Ian Shepherdson of High Frequency Economics, in Valhalla, New York, said on September 17 that he was looking for a "grudging" 25 bps Fed Funds cut when the Fed's Open Market Committee met.

Shepherdson, who with High Frequency's Chief Economist Carl Weinberg publishes Weekly Notes on the U.S. Economy, and Weekly Notes on the Global Economy, adds that the Fed needs to "indicate that it recognizes a softening in the labor market." He says that for now, "The Fed has no choice but to keep cutting rates." Bearish on housing, Shepherdson argues that "massive oversupply [is] depressing [real estate] prices," and "real rates for prime borrowers are 9%," which he characterizes as "outrageously high." Moreover, he worries that in terms of working through the real estate crisis, we "may not be halfway there yet," and that rising unemployment could trigger a "second wave of delinquencies." The silver lining, he says: lower domestic interest rates.

Weinberg cautions that because of cyclical forces already in play, the outlook for Japan and Euroland is less robust. If the credit crisis and resignation of Prime Minister Shinzo Abe lead to a consumer credit crunch, there could be a "deep recession in Japan," and in Euroland.

Two bright spots in Weinberg's forecast are China and the U.K. In China, while food prices are rising, housing and service costs are falling, making China's growth "slower--not slow--at 10% for the rest of the year," versus the "11.5% seen earlier in 2007." In the U.K., Weinberg asserts, Northern Rock troubles notwithstanding, the "U.K. economy is still hot."

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