Deep recession feared in U.S.

Falling business sentiment fuels gloomy outlooks
A new housing subdivision outside of Orlando, Fla. CIBC estimated 50% of U.S. homeowners who took out below-prime mortgages in 2006 will end up in a negative-equity position

Economists are no longer talking about a U.S. recession but a deep recession after figures yesterday showed business sentiment continued to plummet in early February.

Forecasts for a more severe retreat came as CIBC World Markets forecast U.S. house prices would end up sliding 20% before the dust has settled on the American housing meltdown. CIBC estimated 50% of U.S. homeowners who took out below-prime mortgages in 2006 will end up in a negative-equity position -- owing more than their house is worth.

"There seems to be a sense of a very deep-seated collapse in the economy," said Michael Englund, chief economist at Action Economics.

The Philadelphia Federal Reserve's index of manufacturing activity in the U.S. Northeast dropped to -24.0 in February from January's already terrible reading of -20.9. Analysts had been expecting a bounce to about -10 after that sharp drop in January.

"As far as this indicator is concerned, a recession, and a severe one at that, is already underway," said Paul Ash-worth, of Capital Economics.

"The headline index is now consistent with a deep recession, if sustained at this level," said Ian Shepherdson, chief economist at High Frequency Economics, in a note.

The index is based on a survey of manufacturing firms by the Federal Reserve Bank of Philadelphia and their plans for general activity, shipments, new orders, employment and hours worked. It is one of the earliest monthly readings on the U.S. economy and has had a solid track record at predicting national manufacturing and future trends in actual output.

The collapse in the outlook for activity six months out was particularly worrisome, Merrill Lynch said. It posted the steepest decline in the 40-year history of this report, suggesting the United States is facing a recession on par with the early 1990s' downturn rather than the milder 2001 contraction.

Mr. Englund said that although the index measures only sentiment -- gauging what businesses say they will do rather than actual output -- it prompted him to reduce his forecast for first-quarter growth to 0.5% from 0.8%.

He said both consumer and business confidence turned dramatically south as the U.S. Federal Reserve slashed interest rates by 75 basis points in an emergency rate cut in late January.

"The sheer panic tone to the Fed may have actually fed a sense of panic, which is the very thing they were trying to quell with interest-rate reductions, " he said.

While private-sector interest rates were dropping nicely at the turn of the year, rising inflation expectations amid soaring commodity prices have forced rates higher again.

Applications for U.S. mortgages plunged by 11.5% last week as borrowing costs on 30-year fixed-rate mortgages rose by 37 basis points to 6.09%, the highest since late December.

The rise in borrowing costs will be a further constraint on the U.S. housing industry, which is only half-way through its "worst … housing meltdown in the postwar era," said Benjamin Tal, senior economist at CIBC World Markets, in a report.

He estimates 30% of below-prime mortgages taken out in 2006, including subprime and other exotic mortgages, are already in a negative-equity position and that could climb to 50%, prompting the urge to walk away from homes.

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