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Large job losses, mounting claims for unemployment benefits and the prospect of falling exports all point to gross domestic product (GDP) falling 1.8% in 2009, more than expected a month ago. The last quarter of 2008 will show contraction of 5% or so, confirmed by the latest report displaying a drop in retail sales. The contraction will continue 2009's first quarter, likely 3% or so. By the spring quarter, some help should be on the way from a huge package of tax cuts and federal spending, but it will take time to improve consumer spending and business investment. So don't expect GDP to increase until the second half, and even then gains will be modest.

The Federal Reserve is at the end of cutting short-term interest rates, but promises to use other "tools" as it fights a deepening recession and the danger that a deflation mentality will take hold. The Fed might buy long-term Treasuries or corporate debt, or do something else to get credit flowing again in the economy. The Fed has cut the federal funds rate, which banks charge each other on overnight loans, to a range of zero to 0.25%.

But low rates aren't having much impact because the big problem in credit markets isn't the cost of borrowing but the ability to borrow and lend. Banks and investors are afraid and therefore unwilling to take any chances. Many are putting their cash in short-term Treasuries. So other actions by the Fed, such as its buying commercial paper from businesses and its plan to buy up to $600 billion worth of bonds from mortgage giants Fannie Mae and Freddie Mac, should improve the situation over the longer term. Investors eventually will reverse their flight to safety and begin to focus on the huge additions to the U.S. budget deficit resulting from Treasury's efforts to inject capital into banks, insurance companies and possibly nonfinancial firms, such as the big automakers. As a result, the 10-year Treasury will rise to about 4% by the end of 2009. And the Fed and Treasury will strive to keep the 30-year fixed rate mortgage under 6%.

The latest job market numbers show a recession that's deepening. A total of 1.9 million jobs have been lost so far in 2008, with two-thirds of that in the past three months. A loss of about 2.3 million looks likely, and we fear that losses in 2009 could total 3 million. The unemployment rate, which rose in November to 6.7% from 6.5% the previous month, is headed close to 9% in 2009. The losses are widespread, with gains only in education, health care and government. As layoffs increase, incomes shrink and so does consumer spending, inducing firms to continue cutting payrolls. Making conditions worse are tighter lending standards by banks that hurt companies and their customers. While the rising unemployment rate is disturbing, it's still nearly four percentage points below the 10.8% peak hit at the end of the 1981-82 recession. We expect the economy to show some signs of improvement by summer of 2009, but job losses typically continue for a while after a recession ends.

The ongoing plunge in energy prices will continue to pull inflation way down. So low, in fact, that fears about deflation will abound, especially after the record monthly decrease of 1.7% in November following the 1% October drop in the Consumer Price Index. Deflation isn't likely unless oil stays around $40 a barrel throughout 2009. We don't expect such a price collapse, although the weak global economy will continue to dampen demand for energy products for a while. In addition to energy, prices in the U.S. of major items, including new and used cars, airline tickets and hotels stays, are declining. But there are still some price increases consumers are encountering: in rents, education and medical services. Low energy prices will hold the CPI increase to about 1% in 2008 (from December to December), much less than expected a month or two ago. And the increase for 2009 at this point looks to be about 1.5%.
Dept. of Labor: Inflation Data

The housing market will remain in the dumps for six months or so. Surging job losses will keep home buyers on the sidelines and dilute the lure of falling mortgage rates. Signs of that showed up in November as existing-home sales fell 8.6% from the previous month, after appearing to be leveling off over the past several months. New-home sales and housing starts continue to tumble. A bottom appears likely by summer of 2009. After sales hit bottom, they will total only 5 million in 2009. And it will be 2011 before housing returns to a somewhat normal sales total of around 6 million. Meanwhile, foreclosures will continue to increase in 2009, dampening home prices, particularly in Florida, Southern California, Nevada and Arizona. Overall, the national average price will decline about 10% over the next 12 months, albeit with wide local differences.

We see oil averaging about $63 a barrel in 2009, down from the $100 average in 2008. Expect prices to seesaw, however. Crude oil will be pummeled for months by a continuing wave of selling on Wall Street of stocks and commodities in every sector. Eventually this will be sorted out, but look for wild price swings along the way, with oil trading between $35 and $50 a barrel. The Organization of the Petroleum Exporting Countries (OPEC) will continue to throttle back production to ensure that oil prices don't collapse. But by next spring, oil prices should rise to nearly $60 a barrel, as automobile and trucking demand reaches seasonal peaks. Of course, oil prices could surprise and go higher. OPEC's several likely production slices will make supplies tight, especially with a multitude of supply risks remaining around the world, ranging from Nigerian supplies cutoffs to storm damage of North Sea oil platforms. But ongoing slow growth or outright declines in most industrialized nations will likely limit increases in demand for crude to nearly 1% in 2009, roughly in line with this year's 1% growth. A marked slowing of growth in fuel usage by consumers and industries in several Asian nations will help temper demand. Oil supplies will expand around 1% in 2009, year over year.

Gasoline prices should average around $2 per gallon in 2009, around $1.35 a gallon less than in 2008. For diesel, expect to pay an average of $2.80 per gallon, or 85¢ less. Retail heating oil prices should average $2.50 per gallon, about 80¢ less than in 2008, while natural gas will be around $6.50 per million British thermal units, $2.75 less. Propane prices should average $1.85 a gallon or so, down 65¢ from 2008. Gasoline use should rise a tad in 2009 compared with 2008, when purchases fell by around 3%. That marked the first yearly demand decline since 1991, when gas prices soared as the U.S. entered the Persian Gulf War.

Global recession in 2009 will cause exports to shrink by 0.5%, after growing 8% in 2008. Foreign sales to all major customers will drop. Many of the U.S.' biggest trading partners face deeper and longer recessions than the U.S. is likely to experience. Even those economies that do continue to grow, such as China, will see consumers reluctant to spend. And in most cases, the rapid appreciation of the dollar will make U.S. goods and services less competitive. Likewise, the U.S.' recession will cause imports to contract by 3%, after falling 2.7% in 2008. The net effect will be to narrow the trade deficit for the third year in a row. The trade gap will contract to $446 billion, or 3.2% of U.S. gross domestic product (GDP), in 2009, down from $505 billion and 3.6% of GDP in 2008. It will mark the smallest trade gap relative to GDP since 1999.

The 2008 holiday season was a grinch for retailers, and 2009 won’t be much better. A decrease in sales for the holiday season vs. last year is certain: Early estimates of declines range from 2% to 8% (final figures will be available in early January). That’s a major hit, especially coming in the season in which retailers make anywhere from 25% to 40% of annual sales. Lured by deep discounts on loss-leader products, consumers had cash registers ringing on Black Friday, the day after Thanksgiving, but demand quickly petered out in the following weeks. One-stop discount destinations, such as Wal-Mart and Target, drew the most shoppers as consumers sought out value.

Meanwhile, growth will struggle to stay positive in the new year after gaining 2% in 2008. The biggest forces holding shoppers back in 2009 will continue to be worries about home values and job security, as well as expensive fuel, despite recent price declines.