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A U.S. Recession Is Now Probable (but Not Yet Inevitable)

A U.S. recession is probable because sentiment now believes that a U.S. recession is probable. Gillian Tett, Jennifer Hughes, and Krishna Guha writing in the world's best newspaper, the Financial Times: / World - Investors fear new round of turmoil: Investors fear the financial system is moving into new credit turmoil, which could create further losses for financial institutions – and potentially hurt sentiment in the “real” economy. Credit markets are trading at levels which imply that investors assume that the US is heading for a recession, bank analysts and economists have warned. “Recession is getting priced in,” said Jan Loeys, economist at JPMorgan, adding that markets went into “virtual panic mode” last week. “Pressure is building for central banks to become a lot more active and vocal [this] week if they want to avert a collapse in credit markets.” Swaps spreads rose sharply in UK gilts and US Treasuries, amid a flight to quality and fear of bank defaults. Spreads on high-yield corporate bonds and the yen-dollar exchange rate also leapt dramatically, while liquidity evaporated in many corners of the credit markets.

Peter Sutherland, chairman of both Goldman Sachs International and BP, joined those voicing concern. “The US economy is in a mess,” he told TV3, an Irish TV channel, yesterday. “There is a whole big issue...which has not fully played out in regard to providing credit and liquidity to institutions, so I think it is a dangerous period for the world. I think we are going to go through next year, certainly the first half of next year, with considerable traumas.” Rising market tension prompted the European Central Bank to announce on Friday that it would provide fresh emergency injections of liquidity from this week. In recent days, liquidity has evaporated in parts of the European credit markets, as banks have become nervous about trading with each other. Investors are watching to see whether the US Federal Reserve will also provide additional liquidity into the US system. Analysts speculate that the Fed could extend the scale or duration of long-term open market operations, lower the discount rate at which it lends directly to banks, or even announce more radical steps.

Ben Bernanke, Fed chairman, is also likely to reassure the market that the US central bank recognises the threat to growth posed by the relapse.

One factor undermining investor confidence is that the projected size of this year’s credit shock is now rising rapidly. The US government initially forecast $50bn losses on subprime securities. However, investment banks now expect $200bn-$500bn subprime losses – and additional massive losses in other debt markets, such as credit card loans. Lawrence Summers, former US Treasury secretary, writing in today’s Financial Times, says: “The odds now favour a US recession that slows growth significantly on a global basis.” A second problem is continued deep uncertainty about which institutions hold these losses...