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Alex and Dave's Economic "Fore-guess"

Farm Business Management Update, October/November 2006

By Alex White (, Instructor, Agricultural Finance and Small Business, and David M. Kohl (, Professor Emeritus, Department of Agricultural and Applied Economics, Virginia Tech.

What the heck is going on in the U.S. economy?  Gas prices rise dramatically, then they fall.  The housing market heats up, then slows down.  Consumer confidence falls, then it rises.  Alex forecasts gloom and doom, Dave says “Hey, there’s a light up ahead.”  It seems like as if we’ve been on a mini-yoyo for the past six months or so.  After in-depth analysis and many hours of throwing darts at an economic dartboard, here’s our latest installment of the economic fore-guess.

For the past couple of months, the U.S. economy has been facing the prospect of increased inflation.  Increased energy costs were pushing up other consumer costs, while increased production capacity in the manufacturing sector pulled the cost of living higher.  But recent indicators are pointing towards an economic slowdown.  The leading composite indicator has been dropping for the past three months; oil prices are falling; interest rates are slowly increasing, acting as a brake for the economy.  So Alex’s thoughts are still pointing towards “gloom and doom” in the form of a relatively stagnant economy for the next three to six months.

Dr. Ed Seifried and Dave shared the podium in Fargo, North Dakota at a recent bankers meeting.  The following are some highlights from their discussion.

Currently the short-term rate (90-day T-Bills) is 4.76 percent, and the long term rate (10-year bond) is 4.71 percent.  This situation represents a slightly inverted yield curve.  Based upon historical research, this inversion would indicate approximately a 30 percent chance of a recession in the next four quarters.

Economic growth has slowed to a 2.5 percent annual rate.  This factor, along with reduced core inflation and a slowing housing market, would indicate that the Federal Reserve is near the end of its interest rate increases.  Dr. Seifried’s economic models indicate that the federal funds rate next year at this time may be as low as 4.0 percent.  This rate would equate to a prime rate of about 7.0 percent.  At present, the federal funds rate is 5.25 percent and prime is 8.25 percent.

The Composite Leading Index is down 1.5 percent in the last seven months, along with the inverted yield curve – another sign of a slowing economy.

Housing starts are weakening drastically, well below the ideal level of $1.75 million annually.  The current level is $1.665 million.  Building permits are at a 4-year low along with the highest inventory of homes for sale in 15 years at 7.4 months.  Housing has been the driver of the economy, creating the muscle for the heavyweight economy, so the next six months will be interesting.  Time will tell which one is right.

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