U.S. economy in for rough patch, economist says

The Producer Price Index, a key measure of inflation for companies, jumped again Tuesday. Its 9.8 percent rate of increase over the past year is the highest in 27 years, according to a government report. Last week another report revealed that the trailing twelve-month inflation rate for consumers is now at 5.6 percent-the quickest pace since 1991. These new data justify a rising level of concern for the state of the U.S. economy. Adolfo Laurenti, a senior economist with Chicago-based Mesirow Financial Holdings Inc., sees trouble in the next few quarters but remains cautiously optimistic about a recovery sometime in the second half of 2009.

Q: What did you think about the PPI [Producer Price Index] data that came out today?

A: I think they are bad, quite frankly.

I don't think it's a complete surprise because we have had negative readings on the inflation front for quite some time. So the real question is, 'How long will it take for this negative reading at the producer level to filter down and affect consumer prices?'

I think that's the key. Because in the past, to be honest, we had a spike in producer prices, but because of competition, because of productivity gains there was always the ability to absorb higher producer prices and not to translate into higher consumer prices. We are concerned that that ability is fading at this point and that higher producer prices will eventually turn into higher consumer prices.

Q: What are some signs that that is beginning to happen?

A: I think that for several years we had some pretty powerful deflationary strengths and forces in the economy-for instance coming from emerging economies. And then we began to see the biggest spike in energy prices [and] in food prices, and the sense is that these increases in energy and food are really global. So we are now beginning to see inflationary pressure also coming from China, definitely in Europe [too]. I think the feeling is that all of a sudden it might be much tougher to absorb rising costs, and it will be much more likely that these rising costs will be translated into [higher] consumer prices.

Q: There have been some recent drops in commodity prices. Do you see that helping bring food prices back down at any time in the near future?

A: It may help. [But] the corrections I've seen are off the peak. So a [decrease] of 20 percent compared with 3 months ago does not change the fact that compared with two years ago the prices are still almost twice as much as they used to be. I think the changes we have seen [are] a favorable development, but when you look in perspective I do not know if it will be enough to take pressure off.

Q: What do you expect the Federal Reserve to do in the coming months?

A: It's tough. Personally I think that a move [to raise interest rates] by the end of the year would be helpful on the inflation front. On the other side, I have to say there are still a lot of concerns about the macroeconomic situation, and I think many within the Federal Open Market Committee are really concerned about the conditions in the U.S. economy. So I think our official forecast at this point is there will be no move until the first quarter of 2009.

Q: How large a move are you anticipating?

A: I think that right now, because of the current conditions in the financial markets and in the economy, it's very likely they will start just moving by a quarter [percentage] point.

I think it's much easier to cut rates by 50 or even 75 basis points [a half percentage point or three-quarters of a point], rather than increasing rates by 50 and 75. I think there is an argument in favor of [raising rates] faster rather than slower, but I think it will be very difficult to do that even because of the political climate they will be facing. Don't forget there will be a new president [of the U.S. elected] in November. The relationship between the Federal Reserve and the Congress has been a roller coaster. So I think it will be a very complex situation.

Q: How and when do you see the U.S. recovering from its current economic woes?

A: I'm quite optimistic for the second half of 2009. Of course I would prefer to see some recovery before that time, maybe even in the first half of 2009. It's a little bit of a question mark. Our models [take] into account the fact the tax-rebate effect will probably fade away in the fourth quarter. We have a few other items coming off in the fourth quarter. We had enjoyed some strength in residential real estate. It will probably fade away by the end of the year. Exports have really been benefited by the [weak] dollar, but now there seems to be some reversal. So overall we would say that the third quarter should be still OK, but the fourth quarter of 2008 will be weak. It may swing into positive, or it may swing into negative. If it does swing into negative, it's not out of the [realm of possibility] that we will think about recession for the end of the year and beginning of 2009. And I mean a technical recession-two consecutive quarters of negative [GDP] growth. So I am more optimistic about the second half of 2009. But in the next 12 months I think there will be lots of uncertainty.