Danger of recession looms, with early 2008 seen as most treacherous period

But many economists are skeptical. They say that this scenario of the economy as swashbuckling hero from a classic B movie isn't very realistic.

Instead, they are seriously concerned that the economy soon could slip into a recession.

Economists are advising investors to ignore all festivities planned after the third-quarter gross domestic product report is released on Wednesday morning. That report is expected to show growth over 3% in the July-September quarter. Read preview of Q3 GDP data.

But the third-quarter report is like looking at movie flashbacks. It is the growth in the next two quarters where the rubber meets the road. Analysts expect growth in the fourth quarter to slow to around a 1.5% rate, less than half of the third quarter. They call the January-March quarter of 2008 "the dangerous quarter" for a sharp slowdown.

If these worries prove correct, any amount of further Federal Reserve rate cuts expected this week and over the next few months likely won't stop a sharp downturn, but would just soften the blow.

In addition, the most recent Fed Beige Book report, which is a collection of anecdotal report of the central bank's business contacts, gave off a gloomy glow. See full story. And the minutes of the Fed's Sept, 18 meeting reported the Fed staff had trimmed its forecast for growth in the fourth quarter and 2008. See MarketWatch's complete Fed coverage.

Something's not right

Douglas Holtz-Eakin, former chief of the Congressional Budget Office and now an expert on the U.S. economy at the Peterson Institute for International Economics, said his gut tells him the economy might be weaker at the moment than the economic indicators show.

The key factor, he said, is that business confidence appears to be weakening sharply.

The current economic situation reminds him of the slow recovery in 2002. As the economy exited a recession then, the fundamentals improved but job growth remained weak. It turned out the hidden factor was that businesses stayed in a sour mood even though the recession was over.

The fact that business confidence is now at the same low level as 2002 "gives me reason to be more nervous than I otherwise would be," Holtz-Eakin said.

Robert Brusca, chief economist at Fact and Opinion Economics, said he also sensed "there is something going on out there that isn't good...I am concerned about the economy. It is looking pretty weak to me."

One reason the recession fears haven't gained more prominence is that economists are generally loathe to forecast serious downturns.

Carl Tannenbaum, chief economist at La Salle Bank in Chicago, who used to compile economists' surveys from the National Association of Business Economics, said he doesn't recall ever seeing a formal forecast of a recession.

What generally happens in a recession is that the economy starts to slow down, and then growth just falls sharply. None of the complex econometric models in use can forecast this break.

"Most of the models are continuous, where the economy strengthens a bit or softens a bit. It is quite difficult to deal with what could be a step-change, where you get some tipping point where everyone decides it is time to cut back on hiring and capital spending. When that happens, pretty soon everything snowballs into a major slowdown," said Nigel Gault, economist at Global Insight.

Unsettling signs

In recent months, consumer confidence has dropped, job growth is weak, and the unemployment rate has started to rise. See our current story on consumer confidence dropping to two-year low.

But, at the moment, economists will go no further than saying the odds of a recession are one-in-three.

But the housing sector, credit crunch and the price of oil price above $90 has economists watching closely.

"There is a feeling out there that there is more bad news to come," said Gault.