Recession signals in the world's largest economy are flashingred again.

Growth in the second quarter slowed to a pace that has typicallybeen followed by a contraction within a year. Household spendingfell in June for the third straight month; never in the past fivedecades has this happened outside of a slump. The Standard &Poor's 500 Index plunged 16.8 percent in 11 days, performancethat's occurred only twice since at least 1970 without indicating adownturn.

“With so many red flags, the chances of a recession are rising,”said Jonathan Basile, a senior economist at Credit Suisse in NewYork. “A lot of the economic indicators are teetering. We've gonevery quickly from a slowdown scare to a recession scare.”

Signs that the flagging U.S. recovery may fizzle haven't beenlost on Federal Reserve Chairman Ben S. Bernanke and hiscolleagues, who pledged this week to hold interest rates at arecord low through at least mid-2013. Officials said they“discussed the range of policy tools” to strengthen growth and are“prepared to employ these tools as appropriate.”

“Downside risks to the economic outlook have increased,”according to the Federal Open Market Committee statement after theAug. 9 meeting. Consumer spending has “flattened out,” the labormarket has deteriorated and the expansion is “considerably slower”than expected.

'Increased Recession Risk'
“The sum totalof the indicators over the last six months” points to “increasedrecession risk over the coming year,” said Jeffrey Frankel, aprofessor at Harvard University who is a member of the BusinessCycle Dating Committee of the National Bureau of Economic Research,the official arbiter of when recessions start and end.

Five of the nine economists on the NBER committee say theexpansion's staying power may be waning. While the group doesn'tforecast the odds of a contraction, individual members can maketheir own predictions. Martin Feldstein, also at Harvard inCambridge, Massachusetts, and a member of the NBER panel, said lastweek he sees a 50 percent chance of a new recession.

Gross domestic product, adjusted for inflation, cooled to a 1.6percent rate in the second quarter from a year earlier. About 70percent of the time when the pace has fallen below 2 percent, aslump has followed within a year, according to data since World WarII in an April study by Jeremy Nalewaik, a Fed board staffeconomist.

'Policy Mistake'
“At a minimum, theconditions are ripe for a recession,” said Mark Vitner, a senioreconomist at Wells Fargo Securities LLC in Charlotte, NorthCarolina. “When growth slows to less than 2 percent on ayear-to-year basis, the economy is simply unable to withstand amajor shock or policy mistake.”

One major source of weakness is consumer spending, whichaccounts for about 70 percent of the economy. Household purchasesadjusted for inflation dropped in June for the third consecutivemonth — the first such occurrence outside of a recession since1959, according to economists at JPMorgan Chase & Co.

Household sentiment, as measured by the ThomsonReuters/University of Michigan index for July, has receded to alevel seen during the last recession. The Bloomberg ConsumerComfort gauge already is in territory reflective of a slump.

“Consumers are dealing with a labor market that's gotten weaker,a hit to their wealth through declines in the stock market and justa lot of bad news and uncertainty,” said Julia Coronado, chiefeconomist for North America at BNP Paribas in New York. “It makesthem want to be more cautious in their spending.”

Losing Momentum
Manufacturing, whichhelped pull the economy out of the contraction that began inDecember 2007 and ended in June 2009, is losing momentum. TheInstitute for Supply Management's factory index fell last month to50.9, the lowest since July 2009, from 55.3 in June. Figures lessthan 50 signal a contraction.

The spread between ISM gauges of new orders and employmentturned negative for the last two months in the Tempe, Arizona,group's manufacturing and service industry surveys. This hashappened only three other times in the 14 years overlapping the twosets of data, and a recession ensued in two of those three,according to Credit Suisse.

The probability of a slump in the next six months has soared to30 percent from 5 percent at the end of July, Credit Suisse'sBasile said. The latest reading contrasts with mid-2010, wheneconomists were concerned about a so-called double-dip. That scarebarely registered, as the recession probability was 4 percent atthe time, he said.

Jobless Claims
Credit Suisse bases itsforecasts on measures including stock prices, payroll momentum,jobless claims, housing permits, consumer expectations and energycosts.

“It's worrisome, no matter how you slice it,” said Basile, thechair of the ISM's New York business survey. “There's a lot ofanxiety in the financial markets. The ground is shiftingquickly.”

The string of weak data, combined with a downgrade of thenation's credit rating by Standard & Poor's last week, threwmarkets into turmoil that underscores the threat to theeconomy.

A 16.8 percent plunge in the S&P 500 index over 11 days, inthe period to Aug. 8, has occurred just twice without signaling arecession, according to figures going back to at least 1970 fromISI Group Inc. In 1987 and 2002, there was a jump in unemploymentclaims with a short lag, ISI said in an Aug. 9 report titled“Recession Risk Rising.”

The stock market declines reflect investor concerns that theU.S. may be tipping into a contraction, and also aggravate thatconcern by wiping out wealth, said BNP's Coronado.

'Self Reinforcing' Uncertainty
“Theuncertainty in financial markets is becoming self-reinforcing,”said Coronado, who was on the Fed board's forecasting team. “Peopleare seeking safety, and that's not a signal of confidence inanything. They're not ready to go out and hire workers or increaseinvestment or make any kind of decisions that increase growth.”

The bond market also is signaling a less-encouraging outlook.The yield on the 10-year U.S. Treasury note has been moving downfrom 3.77 percent in February and briefly touched a record low of2.03 percent on Aug. 9 after the Fed's dimmer assessment of theeconomy.

The slope of the yield curve has a “reasonable track record inreflecting the change in the economic environment,” said MichaelFeroli, JPMorgan's chief U.S. economist in New York. “It tells you,generally, the outlook for growth and inflation are lower thanpreviously thought,” as people are “scaling back expectations overa longer period of time.”

Shrinking Gap
The shrinking gap betweenthe 10-year Treasury note and the target for the federal funds ratemay be another signal of recession, according to Paul Kasriel,chief economist at Northern Trust Corp. in Chicago. With thebenchmark rate on overnight loans among banks stuck at near zerosince December 2008, the spread between short-term and 10-yearrates has declined in tandem with the falling 10-year yield.

“A narrowing trend in the spread generally indicates weakereconomic growth ahead,” he said in a note following the Fed'sstatement. “The fact that the spread narrowed this much in suchshort time under these conditions is a necessary ingredient for theformation of a recession.”

Some regional reports point to a slump in the making. Athree-month average of the Federal Reserve Bank of Chicago'snational index of economic activity was minus 0.6 in June. Readingsless than minus 0.7 following a period of economic expansion signalan increasing likelihood a recession has begun.

Sign of Trouble
Unemployment is anothersign of trouble. If the three-month average of the rate increasesby more than three-tenths of a percentage point, the economy haseither entered recession or will do so within six months, accordingto Goldman Sachs Group Inc. Chief Economist Jan Hatzius.

Joblessness, while up from 8.8 percent in March, slid to 9.1percent in July from 9.2 percent the prior month as discouragedworkers left the labor force, so “we're not there” in terms of therecession criterion, Hatzius said in an Aug. 5 Bloomberg Televisioninterview. “But if we were to see further spot increases over thenext couple of months, that would definitely be a warningsign.”

He forecasts a one-in-three chance of a renewed recession withinthe next nine months. The unemployment rate will rise to 9.25percent by the end of next year, Hatzius said last week, when hecut his growth forecasts through the first quarter of 2012.

'Muddle Through'
“Clearly, this is whatkeeps Bernanke up at night,” said Robert Eisenbeis, former head ofresearch at the Federal Reserve Bank of Atlanta and now chiefmonetary economist at Sarasota, Florida-based Cumberland AdvisorsInc. “The employment situation is key, but my best guess is thatwe'll continue to muddle through.”

Eisenbeis said he's not convinced another recession is nearbecause corporate profits are climbing.

“I am not sure why the label is that important,” he said,referring to a possible contraction. “Slow growth is slow growth,regardless of what we call it.”

The economy may ride out the slow patch, said Chris Rupkey,chief financial economist in New York at Bank of Tokyo-MitsubishiUFJ Ltd. Consumer spending was weakened in part by gasoline prices,which have fallen from May's three-year high, and an easing ofsupply disruptions from Japanese automakers may help lift car salesand production. Jobs are being created, and unemployment claims aredeclining, Rupkey said.

“A good definition of recession is three consecutive monthlydeclines in nonfarm payroll jobs,” he said in an Aug. 5 note. “Thisis not happening, and there is no sign it is going to happen.”

For economists at JPMorgan, Goldman Sachs and BNP Paribas whohave reduced forecasts for the remainder of 2011 and next year,there's still enough cause for concern.

The chance of a recession is “at 50-50 and it has been rising,”said Coronado, who until last week had put the odds at one inthree. “We're very close to a tipping point.”

Bloomberg News

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