2002 outlook: slow recovery, sustained low rates
By Greg McBride • Bankrate.com

In November, optimism among long-term investors sparked a sharp increase in long-term rates. Some of this optimism was well-warranted: A decline in unemployment claims, a sharp jump in monthly retail sales, a sustained stock market rally and military success in Afghanistan all brought hope.

However, a cold bucket of water has since been dumped on the economic optimists. In addition to cautious statements about business conditions from the likes of Intel, Alan Greenspan's comment last week that "significant risks" to the economy still exist conveys the image that the Federal Reserve remains in a vigilant stance, prepared to cut interest rates further if needed.

Room exists to do just that, as inflation is virtually dormant. For 2001, inflation increased a scant 1.5 percent, after posting a 3.4 percent jump in 2000. This is all the more notable given the 11 Fed interest rate cuts in 2001 to spur the economy. Essentially, 11 matches have been struck, but there's no roaring fire in the fireplace.

The latest round of pessimism centers on the fact that one brief gust of cold air could extinguish the coals.

Mixed economic signals persist, but little doubt exists that the economy has improved from where it was in October. Consumer confidence has steadily improved, the housing sector remains strong -- especially the number of applications for home purchases -- and consumer spending has not plunged as had been feared. The concern is whether the same improvement will be evident several months hence when comparisons are made to the current economic state.

The term being thrown around with greater frequency is "double-dip recession." This refers to a recession, followed by an apparent turnaround that then reverses into another, perhaps lower, recessionary trough.

A double-dip recession could happen if strong consumer spending clears out excess inventories, but then collapses when discounts end. The resemblance to the current strength of spending in the face of prominent retail and automobile discounts and steadily declining inventories has economists, investors and the Federal Reserve increasingly on guard.

What is more likely is that the economy will enjoy a slow and steady recovery over the first half of 2002 and quite possibly longer. This is in contrast to the notion of a rapid and sharp recovery that intermittently takes hold among investors. And if the continued evidence of weakness in manufacturing, disappointing corporate results and equally disappointing business forecasts are not sufficient to bear this out, the dark shadow cast by the comments of Alan Greenspan certainly are having that effect. Instead of debate arising over how soon the Fed would need to begin raising rates, another rate cut is virtually assured, and the idea of rates remaining low is gaining credence.

Stock prices have suffered under the less-than-rosy outlook currently prevailing, retreating after a strong rebound in the last three months of 2001. What has been lousy for stock investors has been good for bond investors and mortgage shoppers, as the fixed payments on bonds look better in an anemic business environment devoid of inflation. Mortgage rates as a result have pulled back to the lowest point since November. You can thank Mr. Greenspan.

Greg McBride is a financial analyst for Bankrate.com.

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-- Posted: Jan. 18, 2002