Goldman Sees Brief US Recession, Trims Rate Forecast To 2.5%

Recession isn't just a market buzz anymore. It is rearing its ugly head in the U.S. after a six-year hiatus, and will prompt the Federal Reserve to cut rates to 2.50%, according to Goldman Sachs & Co. (GS), the world's most profitable security firm.

Goldman's U.S. economic team said in a research note Wednesday that they switched to an "outright recession call" as the housing slump and credit market turmoil spills over into the broader economy, with consumer spending taking a hit. The economists made the call following reports over the past week that showed a spike in the jobless rate, and a tumble in home sales and manufacturing activity.

"The latest data suggest that recession has now arrived, or will very shortly, " said Ed McKeley, senior U.S. economist at Goldman Sachs in New York, in a note to clients.

The recession - which is typically defined as two quarters of contraction in economic activity - is likely to last two to three quarters, Goldman said. The economists expect the Federal Reserve to respond to that by cutting interest rates aggressively, bringing the overnight target rate for borrowing between banks to 2.5% by late 2008 from its current 4.25%, according to Goldman.

Consumer spending will nosedive as slumping housing markets have made it hard for people to tap into their home equity and as banks have tightened credit lending, Goldman said. The contracting economy is likely to push the unemployment rate to about 6.25% by late 2008 from 5% in December, leading to a significant setback in corporate earnings.

One silver lining is that the recession is likely to be relatively mild by historical standards, with a cumulative contraction in real gross domestic product of only about 0.5%. And the economy will eventually walk out of the recession and gradually recover in the course of 2009, Goldman's economists said.

The forces to keep the economy from deeper misery are a helping Fed, which will set aside inflation fears to deal with the economy's weakness, as well as Congress and the Bush Administration, who may agree on a temporary tax break to take effect later this year, Goldman said.

Also aiding the economy is a weakening dollar that has helped boost exports and shrink the trade deficits.

The yield on the 10-year Treasury note is expected to fall to 3.5% by late summer following rates reductions from the Fed. The 10-year benchmark yielded 3.79% Wednesday.