Even After Second Easing, Recession Question Vexes

Alan Greenspan is girding for a fight.

Not since the early 1980s, when the U.S. was getting pummeled by a vicious stagflation downturn, has the Federal Open Market Committee cut rates by so much in one month. Today's half-point cut, following the half-point cut between meetings on Jan. 3, sends a clear message that the Fed is determined to fend off a recession. Nor is today going to be the end of the cuts -- Greenspan's reckoning that the economy is "probably pretty close to zero" last week before the Senate Budget Committee pretty much guarantees there's more to come. Indeed, the fed funds futures market has priced in another 75 basis points of easing by July.

But if it is recession the Fed is trying to fend off, it may be that the battlements have already been overrun, the walls toppled.

A recession is popularly believed to be two quarters of economic contraction, but that's a bit of a simplification. Instead, the arbiter of economic cycles, the National Bureau of Economic Research, defines a recession as "a recurring period of decline in total output, income, employment and trade, usually lasting from six months to a year, and marked by widespread contractions in many sectors of the economy." Using those criteria -- in a call that remains controversial even after today's weaker-than-expected fourth-quarter gross domestic product report -- Richard Berner, Morgan Stanley Dean Witter's chief U.S. economist, believes that recession has already arrived. But while most economists disagree, they also concede that he may have a point.

Buyers' Strike? Purchasing Managers' Index sliding

Source: National Association of Purchasing Management

The last durable goods report shows that new orders, excluding defense and aircraft, showed their largest contraction in December since the last recession. At 43.2, the December Purchasing Managers' Index was just a smidgeon over the recession level of 42.4. It may well pierce that level tomorrow, when the January report comes out. Besides showing that the economy grew at a scanter-than-expected 1.4% in the fourth quarter, today's GDP report showed a disturbing drop in businesses' capital expenditures. Consumer confidence measures have fallen sharply, indicating that there may be considerable softening in the job market.

In the Thick of Things

Whether the current period will eventually carry the recession moniker won't be known for quite a while -- the Bureau of Economic Research is slow to pass judgment -- by which time the downturn may be little more than a somewhat unpleasant memory. Yet if there is to be a recession, we're likely already in the midst of it.

"We're in this interesting period right now," says William Dudley, Goldman Sachs' director of U.S. economic research, "where we're either in a recession now, or else the period of weakness is not going to be deep enough, long enough or broad enough to be classified as one."

Enduring? Durable goods orders, excluding defense and aircraft, six-month change

Source: U.S. Census Bureau

If the U.S. is not in recession now, according to Dudley (who puts the odds at about 1 in 3), the Fed's aggressive easing should be enough to inoculate the economy against one. Already, lower rates have led to something of a boom in mortgage refinancing, which should help to shore up the consumer's balance sheet. With warmer weather, natural gas prices have fallen appreciably, helping to ease the home-heating burden. Meanwhile, the corporate bond market has improved significantly, giving companies easier access to funding. That should revive capital expenditures.

Is It Academic?

And even if we have entered recession, most forecasters believe the Fed's aggressive rate-cutting will help the economy right itself by the latter part of the year. Seeing that dynamic at work, many investors reckon that it simply doesn't matter whether there is or isn't a recession.

"Investors are looking out to the second half of the year, and they should be looking out to the second half of the year," says Edward Hemmelgarn, president of Cleveland-based hedge fund Shaker Investments. "My only concern would be if the Fed starts backing off. As long as they don't reverse course here, you want to be long the stock market."

Morgan Stanley's Berner, however, is a bit troubled by the conventional wisdom in the markets that good news is bad news, because the weaker things are, the more the Fed will ease, making the economy's recovery all the more powerful. Even though his forecast calls for a strong rebound in the economy by the end of the year, he worries that there remain significant downside risks.

"Once you're in a recession, gauging how long and how deep it will be is difficult," he says.