Are we headed toward a recession?

Wall Street plummetted today despite the quarter point rate cut by the Feds on the Feds funds rate. Investors were looking for a more aggressive response from the Federal Reserve, along the lines of a half point rate cut, to fuel growth in a slowing US economy. The slowdown is something the Feds acknowledged, but they stopped short of calling it a recession. The Economist magazine believes however that it is not a matter of if a recession will happen but when. Reduced consumer spending will be the primary cause of the recession this time around. Consumer spending, which accounts for a third of US economic activity, is expected to soften because of the recent mortgage credit crisis and a slumping housing market, higher oil prices and higher inflation.

The housing market which has been in decline for around 2 years, is expected to continue falling in 2008. Lower home values reduce lines of credit and subsequently reduces consumer spending power. Oil prices, which have been flirting with the $100 a barrel price range for the past several months, are expected to remain elevated in 2008 due to continued high demand for oil in China and India. High oil prices translates to higher commodity prices, and this combined with lower interest rates, are a recipe for rising inflation. All these factors combined are expected to significantly reduce consumer spending, which will slowly but surely drive the economy into a recession.

While a US recession is highly likely, economists believe that this recession will not lead to a global slowdown, like most other US recessions have. Typically, reduced consumer spending in the US affects emerging markets such as China and India that export heavily to the US. However, increasing local demand within China and India and other emerging markets is going to offset the reduced consumer spending in the US this time around, leading to a softer global slowdown, if any.

Time will tell us where things are headed but the ways things look right now, be prepared for a recession sometime in 2008!