Is the economy sprialing into recession?

We had quite a number of weak and mediocre economic reports this past week, suggesting that the economy is a lot weaker than many had thought, but I would note that a lot of these reports are simply rear-view mirrors on the state of the economy in August and September. That said, I am also prepared for some significant relative weakness in October and November, but by December the vast bulk of the housing slump will be well behind us. Q4 GDP could well be rather weak, but not recessionary and not an indication of GDP in 2007.

Even if October and November turn out to be relatively weak, that's still well within what we could have expected as the housing boom was tamed by the Fed. The simple fact that the economy is not already in recession is a testament to the tremendous underlying strength of the economy.

Commercial construction is still quite strong. Construction of apartments is likely to bounce upwards strongly over the coming year simply to keep up with population growth, not to mention the tremendous amount of money sloshing around that needs a productive home.

And we will likely see some up-tick of housing demand as mortgage rates and housing prices fall back. Note that mortgage rates are set primarily by the supply and demand for mortgage-backed securities (MBS) and more sensitive to the 10-year Treasury yield than the Fed funds target rate. As long as investors can get a better yield on MBS than Treasuries, mortgage rates will be kept down. 

Sure, a lot of people may have (unreasonably) expected the economy to bounce back to 3% GDP growth in Q4, but even 2% will be quite decent, all things considered. Q1 of 2007 will likely be so-so, say 2.5%, and then Q2 of 2007 is likely to be much stronger, back up to 3% if not 4%.

The real bottom line is that there is simply too much cash floating around for the economy to sink into recession.

-- Jack Krupansky