Economic crystal ball foretells murky future

When Faith Freeman of Primal Elements looks at her order books for the specialty soap and candle company, she sees one thing: caution.

Customers, particularly the mom-and-pop gift stores that make up the bulk of her business, are ordering fewer items at a time, placing, say, two 500-item orders in different weeks or months, rather than committing to one big 1,000-item order at the start. And this year they ordered far closer to Halloween, increasingly an important sales time.

That suggests to her that business owners, and their customers, are facing uncertain times. Seeing that has made her more cautious as well, particularly heading into the key holiday shopping season.

"We're supposed to be in these wonderful, affluent times, but people are feeling pinched," says Freeman, who started the Huntington Beach, Calif., company with her husband, Scott, in 1993. The housing slump, higher prices for a number of essentials, particularly gasoline, and news of layoffs are likely making people nervous, she says.

Federal Reserve Chairman Ben Bernanke and his colleagues meet Tuesday and Wednesday to discuss interest rates as the economy is indisputably slowing.

But it's uncertain how deep a decline is underway or how long it will last, making the economic crystal ball unusually murky. Further clouding the picture is the recent run-up in oil prices to near-record levels even when adjusted for inflation, a development that could slow consumer and business spending while also sparking inflation worries. That complicates matters for the Fed because the biggest issue for central bankers isn't where the economy is now, it's where it's going to be six months or a year away, when interest rate moves have had time to have real effects.

In a USA TODAY survey of 53 economists conducted Oct. 18-24, 62% said the economy was poised to get worse before it gets better.

"The best description I would give right now is, it's kind of like running in quicksand," says Richard Moody, chief economist at Mission Residential in Austin. "We have some forward momentum, but we could easily get dragged down by a number of factors."

The housing downturn will likely lead consumers to spend less well into 2008, he says. But Moody, like nearly every economist in the survey, still expects the downturn won't turn into a full-blown recession, arguing that consumers, the main engine of the economy, won't stop spending entirely.

Economists said there was a 25% chance of the economy sinking into recession in 2007 and a 30% chance of a recession in 2008. While the forecast for 2007 was identical to a USA TODAY survey conducted two months ago, economists increased the 2008 recession odds from 20% in the August survey.

"I don't think we'll be in recession, but to a lot of people, it will feel like one," Moody says.

Javier Escobedo, managing partner of Ole, a New York City-based advertising and marketing agency whose clients seek to attract Hispanic consumers, says a number of major clients have put projects on hold in the past few weeks. Before the end of the year, they will have to decide if they are going to pick up where they left off in the summer or cancel the projects.

"We're at a crossroads where things can get back to normal or they can get really ugly," says Escobedo, whose 4-year-old firm counts major retailers and other large firms among its clientele. "I say there's a 50/50 chance of a good '08 or a rough '08."

Split decision on rate cut

The Federal Reserve cut interest rates last month by a half-percentage point, the biggest decrease in nearly five years, in a bid to prop up an economy under threat from a crunch in financial and credit markets and a rapidly deteriorating housing sector. The Fed's target for short-term interest rates, which influence borrowing costs economywide, is now 4.75%, the lowest in more than a year.

The economists in the survey are divided on what Fed officials will do at the conclusion of their two-day meeting Wednesday. Fifty-one percent say they expect the Fed will cut rates by a quarter-percentage point, while 45% anticipate policymakers will sit this one out. Two of the 53 people expect the Fed will cut rates by another half-percentage point.

"These are somewhat uncertain times," says William Hummer, chief economist at Wayne Hummer Investments in Chicago, who expects the Fed will cut by a quarter-percentage point on Halloween. "It would provide reassurance to the markets that the Fed is watching things, that they know there are unanswered questions out there."

One of the biggest uncertainties is housing: How much further will the market fall and how much, if at all, will consumers react to the decline? Forty-five percent of the economists say that over the next six months, the impact of the housing downturn will intensify; 35% say the impact will be about the same as it has been. And 20% expect the impact to lessen.

Jeff Noddle, CEO of Supervalu, expects housing to act as a drag on the economy into 2008. The Eden Prairie, Minn.-based firm owns 2,500 grocery stores nationwide under a variety of names, including Albertsons, Shaw's, Save-A-Lot and Jewel, and runs a grocery supply chain network for smaller grocers.

"Whether people are getting their mortgages reset … or the fact that they know that some of the equity in their homes has gone away, that has a psychological impact," he says. "Fuel and housing are the main reasons that I would point to next year and say I think it's a slower growth year for the overall economy."

Business at Medford, Ore.-based Medical Eye Center's three offices in Oregon and California is strong, leading them to add new doctors and support staff, CEO Keith Casebolt says. But he has noticed a slight softening in demand for premium services, such as Lasik surgery, custom cataract lenses or high-end glasses, items that insurance and Medicare don't pay for.

A softening housing market and higher interest rates for those with adjustable-rate mortgages may mean customers are less likely to take out home-equity lines of credit, giving them less money to spend on non-essential items, he says.

The firm plans to break ground in April on a new office in Medford. "We are weighing what happens with the economy. How big a building do we build? Those are tough decisions," he says.

Worries about credit, energy

In addition to housing, continued concern about problems in the credit markets and potential availability of financing were top risks listed by the economists.

Ole's Escobedo says not only is he getting hit by postponed projects, but his bank recently reduced his line of credit.

"It's a vicious cycle," he says. "I'm trying to juggle cash management on one side, which is tough, and I'm trying to maximize my revenue, which is also tough. … You have less flexibility to maneuver through the downside."

Economists also pointed to high energy prices as a concern.

High energy costs force consumers to spend more to fill up their cars and to heat and air condition their homes, leaving them less to spend in other parts of the economy. The U.S. average price for a gallon of regular gasoline was $2.823 last week, 62 cents higher than a year ago, the Energy Department said, as record oil prices and tight supplies have lifted prices. The department has warned that heating costs this winter could hit records.

Elevated diesel prices also are squeezing business owners, who are being charged higher delivery costs, which could be passed on to consumers. The nationwide average price of a gallon of diesel was $3.094 last week, 57 cents higher than a year ago and the highest since prices jumped after Hurricanes Katrina and Rita two years ago.

Richard Chenoweth, who owns Scranton's Restaurant & Catering in Pascagoula, Miss., has noticed lately he's selling more hamburgers and salads, vs. steaks and other higher-priced items. While his catering business is doing well, he notices some people are trying to trim costs. He thinks energy costs deserve at least part of the blame.

Joules Angstrom Inks in Pataskala, Ohio, is seeing sales gains of about 30% this year. But the firm, which manufactures specialty ink that uses ultraviolet light to transfer from liquid to solid states, a process that is more environmentally friendly, is seeing some of those gains eroded by higher costs. The ink is petroleum-based, so it costs more in energy to manufacture, and transportation surcharges have jumped to double digits. With competition heavy, the company can't pass along the added costs, says President Patrick Carlisle.

"They eat you up, and you can't pass them on," he says.

Bruce Boring, owner of The California Wine Club, a wine-of-the-month club featuring small state wineries, says his transportation bill is nearly equal to his wine costs as fuel surcharges, which are added on top of the regular shipping bill, have leapt to as high as 33%. That means a shipment that is originally $100 ends up costing him $133.

But Boring passes along those costs to his customers and, so far, no one has canceled their account because of higher fees. Pre-Christmas sales are up 14% from a year ago to about $1 million.

While sales are likely strong in part because of the firm's high-end clientele, Boring also thinks things really aren't that bad outside of the housing market.

"The economy is stronger than most people think," he says. "We probably already have hit bottom."

Some room for optimism

Some economists and other business leaders say there are plenty of reasons to be optimistic.

Economic growth is "analogous to a car running at a 45 miles-per-hour pace," says Richard Yamarone, director of economic research at Argus Research in New York. "We're plugging along. It's not at a desired pace, but it's far from what we can call a recession."

On the plus side: Manufacturing activity is healthy, exports are growing at a strong pace, the unemployment rate at 4.7% is at a low level and incomes are growing. Most important, consumers have been tough to shake, despite the housing headwinds.

"We have seen very little backlash by the consumer from the housing (market), which has been in recession for two years now," Yamarone says.

Sanjay Chandra, a partner at Trinity Advisory Group, a Southlake, Texas-based private-equity firm that buys and sells companies and helps entrepreneurs raise money, also says concerns about the consumer are likely overblown.

"The American consumer will continue to spend," he says. "I'm not that concerned, but you (still) have to be careful."