This morning I was in the panel on the 2007 global economic outlook together with Laura Tyson, Jacob Frenkel, Min Zhu and Montek Ahluwalia.

I was the only one who expressed some concerns about a US hard landing that could take the form of a growth recession or an outright recession. However, other panel members agreed that there is complacency in financial markets and underpricing of the geopolitical and economic risks in the global economy, including the risk of a backlash against globalization. Worries about the growth of debt, credit and credit derivatives were expressed by several panel members.

The consensus, clear at the panel, was for another Goldilocks year for the US and global economy with the US achieving a soft landing.

But I pointed out that there are three bearish forces that will threaten Goldilocks in 2007 and create economic and financial vulnerabilities; they are, in my view:

1. the deepening housing recession that has not bottomed out and that is spreading to other sectors sectors of the economy;

2. the delayed effects of the Fed Funds increase and the beginning of a credit crunch in the mortgage market as 16 subprime lenders have closed shop in the last two months and as defaults and foreclosures are rising among subprime borrowers (a study suggests that 20% of them will eventually go into foreclosure);

3. the fact that oil even at $55 is still high in real terms relative to a few years ago, and that the factors that led to lower oil prices are temporary (unseasonably warm weather, temporary reduction of geostrategic risks); so oil could go back to $60 or higher this year.

A US hard landing could certainly take the form in 2007 of a growth recession (growth in the mediocre 0% to 1.5% range) from Q2 on (as the factors that boosted growth in Q4 and possibly Q1 are transitory); this hard landing in the form of a growth recession is the view recently expressed, among many others, by Munchau and Brittan in the FT.

There are still meaningful risks of an outright recession this year. However, a number of factors – some temporary - have recently reduced the risk of an outright recession: the sharp fall in oil and energy prices; the bubbly behavior of equity markets that has kept financial conditions loose; the effect of the persistent of global liquidity in spite of the Fed tightening; the still moderate income growth in spite of a looming slack in the labor market; the temporary boost to output in Q4 and possibly in Q1 from transitory factors.

Some leading indicators still suggest the risks of an outright recession: the inverted yield curve; the manufacturing ISM that is borderline recessionary; measures of business confidence; the still weakening housing and a coming credit crunch in some parts of the mortgage market. But other leading indicators suggests a reduction of outright recessionary forces: lower oil prices leading to higher consumer confidence; real income growth and still low initial claims of unemployment; bubbly equity markets; easier financial conditions with credit boom and low risk premia. 

We do indeed already have a housing recession that is not bottoming out (based on a variety of indicators); and we have the beginning of a non-residential construction slump, an auto recession, and a manufacturing slump; we also have a real investment slump with falling capital goods durable orders for two months now (as highly profitable cash-flow rich firms do not invest but are giving back their earnings to shareholders in the form of the biggest share buyback in US history).

But housing is only 6% of GDP while consumption is 70%. So any hard landing – whether a growth recession or an outright recession – will require a sharp slowdown of consumption growth. I do believe that the next leg of the US slowdown, that will lead at least to a growth recession, will be the consumer weakened by a variety of factors:

-         The job losses in housing and manufacturing will build up over 2007 and reduce job growth from 150k jobs to about 50k jobs per month over the next few months. So, labor slack will reduce income generation.

-         The negative wealth effects of falling housing values and falling mortgage equity withdrawal will slow down consumption as households with negative savings have been using their homes as their ATM machine for too long.

-    Rising reset interest rates on monster mortgages, ARMs and subprime loans will increase debt servicing ratios.

-        The coming credit crunch in the subprime sector will serious hurt subprime and other ARM borrowers.

So, while the US consumer will be the last shoe to drop it will drop this year as the consumer is at its tipping point in spite of the recent temporary factors that have boosted its consumption. So I do not believe that the economy will achieve the soft landing predicted by the economic consensus as the balance of risks and vulnerabilities suggests further economic weakness ahead. Certainly low oil prices would help and increase the chances of a softer landing; but oil prices may soon go back to levels closer to $60 and the other vulnerabilities in the economy remain serious and serious drags on growth.

Finally, as Larry Summers recently put it, the biggest fear is the current lack of fear in financial markets. These markets are priced for perfection and blissfully ignoring the coming risks, geopolitical and economic. But any geopolitical and/or economic shock may surprise markets and, given the current house of cards of leverage, credit growth, asset bubbles and opaque and mushrooming credit derivatives, the repricing of risk could get painful once a variety of geopolitical and/or economic shocks do occur this year.