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Interview given to Pro Finance Service by Dr. Ian C. Shepherdson, Chief U.S. Economist at High Frequency Economics. 29.01.2008.

Dr Ian C. Shepherdson has been described by the London Times as one of "the best economists in the City". Íå offers a unique transatlantic perspective on the U.S. economy. His publication, Daily Notes on the United States, is widely read by investors, policymakers and dealers in 20 countries. Prior to joining High Frequency Economics, Dr. Shepherdson was Chief Economist, USA, for HSBC Securities, Inc. in New York, where his views on the U.S. economy and markets guided the company's senior decison-makers and clients around the world. He also spent six years with HSBC in London, latterly as Chief U.K. Economist. Dr. Shepherdson was recently named top U.S. forecaster of 2003 by the Wall Street Journal. He is frequently quoted in the U.S. and international press, and he is a regular guest on U.S. National Public Radio's Marketplace. He earned his Ph.D. in Economics from Loughborough University, in England. Today's interviewee of the Pro Finance Service is one of those people who live in tow cities at once. We managed to speak to Mr. Ian Shepherdson while he was staying in the capital of the United Kingdom.

December existing home sales numbers in the USA were published last week and newswires cited your opinion in relation to this report, saying that you did not see any improvements yet and, moreover, expected continued downside home prices movement as low nominal rates were not attractive for buyers yet. December new home sales report published on Monday was also highly negative. Tough that was the previous month data. This week the FED lowered the rates aggressively. How can this influence the real estate market perspectives and when will the FED actions actually be felt on the property market?

Well, in fact the FED's rate cut will not make any big difference for the housing market. Because, when people buy a house, they buy a real asset. In this case a real interest rate is deemed to be more important. And a real interest rate has been rising rapidly because the house prices are falling. Now a subprime borrower with certain credit limitations may get a credit on 5.5% which is low by historic standards. But we are speaking about buying a depreciating asset, which is a very good reason for people just to wait. Inventory of unsold homes are enormous - and everybody knows that. People are aware of millions of houses on the market eager to find its buyers. So why to take a credit and to buy a depreciating asset? Borrowing money people are expecting to buy cheap asset that is supposed to grow in value. Not vice versa. Again, expectations play a very important role. Investors are expecting the continued price fall and prefer to postpone the purchase and that speeds up depreciation and increases market pressures. Finally the builders will have to freeze some of the projects, which will lead to deterioration of construction sector activity and output. At some point the inventories will start reducing and than people will realize that the prices will have reached the bottom. Then they will have a chance to get a bargain. But now the inventories are still piling up and the bottom is still nowhere to be seen.

The FOMC meeting is considered to be the key event of the week. February federal funds rate futures price in 90% possibility of another 50 b.p. interest cut. We are pretty puzzled by this situation as we are expecting 0.25% cut on the basis of the statement published on Tuesday. If the FED acted in response to the worsened economic situation and not to the stock market collapse, the only reason to cut rates on Wednesday will be a series of negative economic statistic published after the rate-cut on Tuesday, starting with already issued house market reports and finishing with 4 quarter GDP. Could you share your opinion with this respect?

I think they'll be compelled to reduce rate on tomorrow meeting otherwise the market will collapse. Actually the market stabilized only due to this 0.5% cut expectations. The FOMC was in a very difficult position last week. It was the market that forced them to take these measures, and not the horrific macro economic data. Anyway, fundamentals simply cannot be so awful that the FED could not have waited another week until the scheduled meeting. I believe the key reason they made this decision was the market conditions. They were frightened that the fall would continue like a snowball and finally lead to a real catastrophe. Though the FOMC members underlined the economic perspectives worsening in their statement. I think they grossly underestimate the problem. We have the revised forecasts published next week and I expect significant downside revisions. One might find it strange that they preferred to split the rate reduction in two stages. At first glance it would seem only logical to slash rate at 1.25% at once. But it has its rational. If they had reduced the rates at 1.25% at the extraordinary meeting, the markets would have become nearly hysteric. People might have started asking themselves: "the FED knows something horrible that I don't know". People would have started to panic, clutch their head and cry about by far the greatest reduction ever.

You are the first among American experts to admit that the Federal Reserve was scared by the events we observed last week. You may be right, but then, reducing the rate tomorrow the FOMC will surely focus on economic health rather than the market collapses. Meanwhile statistical data of recent months prove that the economy is supported by, so to speak, two pillars: labour market and consumer spending. Though it seems they are already pretty tired of their life-saving function. Could you share with us your perception of employment growth perspective in the wake of January labour market report scheduled on Friday.

The situation developing on the labour market is the direct consequence of credit market conditions. Companies have stopped hiring new employees, which resulted in slowing of non-farm payroll growth. Though we haven't seen any negative data yet, the unemployment is growing and this fact cannot be denied. Companies do not foresee any improvements; on the contrary, people believe that the crisis will only be longer and more severe than it was initially expected. The earnings are eroded. They have no choice but to stop expansion and, finally, go on with staff reduction. We shall see negative employment data in the next couple of months.

Then what about consumer spending? It was the high level of consumer spending that helped the American economy to stay afloat during the recent months. Do you believe that the American Consumer will continue to show a substantial shopping appetite, or negative dynamic is also to be expected?

The consumer spending has already begun to slow, the negative trend has already started in the end of November, in the beginning of December. Now the collapse will become only more pronounced. The situation is already close to catastrophe. Weekly data has been horrible for some time now; they reveal the drop during the last nine weeks. I believe we are going to see the drop of consumer spending in the service sector, especially in tourism, entertainment and leisure. Naturally, when people have cash they go and spend it, but now it is different. Interest rates are growing, fuel prices are growing; people simply do not have any spare money. And there is nowhere they can get it. Problems on credit markets deprived them from the opportunity to borrow funds while the house prices depreciation does not allow them to use it as collateral for refinancing purposes. I suppose, economy growth in the 4 quarter will not exceed 3%, while in the first quarter it can fall to 1.5%. I think we are on the verge of a very deep and long economy slowdown.

Dr. Shepherdson was interviewed by Oleg Surovatkin, Michael Shulgin and Tatyana Chepkova. ProFinanceService.com