Despite Boom, Some Economists See Growth Slowing in Second Half

The economy is going to slow down. The questions are how and when it will happen.

The expansion, now in its seventh year, may soon show signs of advanced age, for example, rapid consumer debt growth and a widening trade deficit. More probably, rising interest rates will set the stage for change.

"The strong first quarter is now well behind us, and with it the boost to business from a mild winter," said economist David A. Levy. "The latest data indicate that the economy is growing solidly but not booming."

Indeed, Bruce Steinberg, chief economist at Merrill Lynch & Co., predicted economic growth would slow to a still-healthy 2% annual rate in the current quarter-down sharply from 5.8% in the winter quarter.

But if growth stays firm in the short run, rates may ultimately go up and in turn undermine the stock market and consumer confidence, Mr. Levy said. And if those things happen, then "a recession or near-miss" could ensue either late this year or next year.

"Too many investors now have too rosy a view of the risks and rewards in the stock market, and some are spending in anticipation of future portfolio gains," said Mr. Levy, who prepares the Industry Forecast newsletter at the Levy Institute of Bard College, Annandale, N.Y.

Why? Because if the recent zig-zag pattern of consumer activity holds, a spring lull will be followed by a hot summer that would spur the Federal Reserve to raise rates again, he said.

The Fed tightened credit a notch on March 25, then surprised many by doing nothing on May 20. The central bank's next monetary policy session is scheduled July 1-2.

Most economists think further Fed action has only been postponed. Interest rate futures markets are continuing to "price-in" a half-point advance in short-term rates by December, noted Nicholas S. Perna, chief economist at Fleet Financial Group Inc.

Mr. Perna said he suspects the Fed did not act in May because it lacked the "political cover" to do so amid reports of slack inflation and sensitive federal budget negotiations in Washington.

In coming months, however, he expects the nation's unemployment rate to drop from its already low 4.9% level and raise new concerns at the Fed. The May unemployment rate and labor market survey data are to be released Friday.

Indeed, "the current expansion is so old that the Fed is at the center of the stage," said Mr. Shilling, who runs his own consulting and money management firm, A. Gary Shilling & Co., Springfield, N.J.

"Does that mean that we are close to the usual late-cycle phase in which a series of Fed rate hikes ultimately kills the economy?" he asked. "That's the odds-on bet."

The long bull market in stocks has "put fear to flight," he cautioned, "and greed reigns supreme. There are too many green investors who have never suffered through a bear market-the last real one was in the early 1970s." Mr. Shilling urged clients to use any further rallies in U.S. stocks and bonds to "lighten up" their holdings.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER