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The aftershocks from the credit crisis, which continue to spread to other sectors, have not only put the economy into a recessionary
state but also have damaged its growth prospects until 2010. Any additional uptick in oil prices could put the economy further at risk and recovery further away.
Despite all of the aftershocks from the credit fallout, oil has been the wild card testing the Fed’s patience. If the price of oil does not retreat below $100 per barrel by October on a sustained basis, worries of inflation will cause the Fed to raise rates much earlier than expected.
Expect the price of oil to drop to an average of $89 per barrel in the fourth quarter of 2008, allowing the Fed to hold off on rate hikes until next spring. However, anticipate that the Fed will be somewhat aggressive raising the federal funds rate by 250 basis points by mid-2010.
The Fed hikes will begin even before growth catches its stride, which is a departure from the norm. But rather than waiting until job growth picks up to normal levels, the Fed will hike the federal funds rate to show it is serious about containing inflation.
While the Fed will be able to stave off inflation, the fragile health of the banks will cause the economy to recover at a slow rate.
Despite efforts by the Fed and the Treasury to help bail out the financial industry, lenders still need to keep liquidity or cash on hand to deal with charge-offs that they will have to take as loans continue to go sour. Still, some banks are on the brink of failure and it will be up to the FDIC to bail them out–and, should they run short of funds, look for the government to bail out the FDIC, leaving taxpayers with the tab. Thus, my forecast calls for an anemic recovery in 2009, and
a below-potential growth in 2010.
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