PRINTMarket Update -- Economic Comment
September 19, 2007
Ding Dong! The Witch is dead. Or, at least one gets that impression by the giddy investor reaction to the Fed's decision to cut the federal funds rate by 50 basis points to 4.75% and cut the discount rate by 50 basis points to 4.75%. We were surprised—and pleased—by the Fed action, but we are skeptical that we can all now hold hands and skip down the yellow brick road. The Fed's aggressive action has succeeded in reinvigorating financial market participants' risk appetite, but it does not appear that investors are going to return to acting like dogs under a buffet table. Thus, we continue to expect sharp declines in homebuilding and home prices to limit the pace of economic growth to a sub-par rate. Fortunately, the 50 basis point cut in the funds rate and the loosening of financial market conditions improves the chances that the economy will avoid a recession, but, unfortunately, it is unlikely to prevent a downturn.
We forecast that real GDP growth will slow from an expected 2.5% pace in the third quarter to less than 2% in the fourth quarter and something closer to 1.5% during the first half of 2008. As the economy slows, we expect the Fed to respond with additional reductions in the funds rate. At this point, it is unclear how much easing will be needed. That will depend on the speed and depth of the downturn, the level of angst in the financial markets, the stubbornness of inflation pressure, and the evolution of global conditions. For now, we expect that another 50-75 basis points in easing will be forthcoming.
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