Thread: KATRINA'S IMPACT ON THE U.S. ECONOMY

Katrina's Impact on the U.S. Economy The Economic Outlook Group
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THERE IS A REAL SENSE OF FOREBODING about the economy now that Hurricane Katrina has struck with full force. This storm will be the most devastating ever for the U.S. oil and refining industries.

Indeed, many forecasters have rushed back to the drawing boards in the aftermath of this hurricane to assess its impact on economic growth, energy prices, consumer spending and, of course, interest-rate policy.

Here are a couple of immediate conclusions:

First, the odds are better than 50/50 that the Federal Reserve will postpone another rate hike when the Federal Open Market Committee meets on Sept. 20. This is not to say they will not resume raising rates in November and December. It's just that Fed officials may want to evaluate the extent of Katrina's impact on business activity, consumer demand and inflation pressures.

Second, growth in consumer discretionary spending will weaken dramatically as Americans dig deeper into their pockets to pay more for heating oil, gasoline, rising interest payments and post-hurricane reconstruction. The growing stress on household finance also means the housing boom is effectively over!

While the expected reconstruction following the hurricane will help stimulate some business activity in September and October, our forecast calls for a 2.8% gross domestic product growth in the final quarter of this year (down from 3.1% from our pre-hurricane outlook).

For 2006, we see a 35% chance of recession -- with the probability of a growth recession (with the GDP expanding in the 2.5% range or less) at 55%. This means there's only a 10% chance we'll see the economy race ahead 3.5% or more next year.

Finally, the August employment report to be released this Friday is still expected to show a gain in payroll of around 135,000. Moreover, job growth in September will likely register a spike as workers are hired to repair the storm damage.

But we see anemic job gains in the final three months of the year, with average increases of less than 150,000 (versus 170,000 in our previous forecast).

The bottom line is this economic expansion is in real jeopardy due to a convergence of troubling economic developments here at home, and deteriorating conditions in the Persian Gulf. We could be at the cusp of the turning point in the business cycle.


[align=right]--Bernard Baumohl, executive director[/align]