Recession dead ahead?

With a government report showing the weakest job gains since 2003, some analysts are calling out a bleak forecast. But the negative news may just be enough to force the Fed into action.

By Elizabeth Strott

After the worst monthly jobs report in four years, people are starting to use the R-word again.

"These jobs data are the strongest evidence so far that the economic expansion is grinding to a halt," Peter Morici, professor at the University of Maryland School of Business and former chief economist at the U.S. International Trade Commission, wrote in a note to clients Friday morning.

"Slow jobs growth, along with the shortages of mortgage and business credit, declining home prices and residential construction, and falling industrial production, indicate the risk of a recession for 2008 is high," he continued.

The Labor Department reported Friday that nonfarm payrolls rose by a mere 18,000 in December 2007, far fewer than economists had expected, and the weakest month-to-month change since August 2003.

The consensus estimate was for a gain of 58,000 jobs last month, although analysts' estimates had ranged broadly, with some as high as 85,000 new jobs.

Meanwhile, the unemployment rate jumped to 5.0%, up from the 4.7% in November, and up from 4.4% in December 2006. Average hourly earnings rose 7 cents, or 0.4%, slightly higher than the expected 0.2% increase.

"This tells you that the strains from credit problems and so forth that have been developing the last six months are starting to bite, and they're biting in a way that now finally draws consumption into question," Neal Soss, chief economist at Credit Suisse Group, told Bloomberg News.

Fed action required?

Stocks tumbled on the news Friday, but many investors and analysts saw a silver lining: that the Federal Reserve will now be forced to move decisively.

Morici expects the Fed to "aggressively cut interest rates to combat the U.S. slowdown."

Phil Orlando, chief equity strategist for Federated Investors, says he expects the Federal Reserve to cut interest rates at the next Federal Open Market Committee meeting on Jan. 30 and then again in February -- outside of a scheduled FOMC meeting.

"All of the economic news is negative," Orlando told CNBC. "This ensures that the Fed has got to get engaged more aggressively than they have been."

And that, he says, is good news: "The fact that the Fed is engaged, we think is going to be a positive over the course of the balance of the year for stocks."

Not so fast . . .

According to the federal funds futures trading on Friday afternoon, most people think that the Fed will cut the federal funds rate by a quarter of a point to 4%, and there is only a 34% chance that the Fed will cut any lower.

But investors shouldn't start counting their chickens.

Morici warns that "the Federal Reserve is in crisis, because its mix of policies addresses an old-style recession, one premised on inadequate consumer demand but solid financial institutions.

The coming recession, he says, will be different: "This recession has its origins in questionable banking practices and a breakdown of investor trust in the integrity of Wall Street's most venerable banks and investment houses."