Oct. 2 (Bloomberg) -- The U.S. economy has slowed more dramatically than most economists expected just a few weeks ago, leaving it more vulnerable to a recession.

Forecasters at Goldman Sachs Group Inc. and AllianceBernstein Holding LP in New York have cut their growth estimates for the just-ended third quarter to an annual rate of 2 percent or less. They don't foresee much, if any, improvement in the fourth quarter: Auto-production cuts and slumping home sales are likely to overwhelm any boost the economy gets from lower gasoline prices, they say.

``We're decelerating fairly significantly,'' says Peter Hooper, a former Federal Reserve official who's now chief economist at Deutsche Bank Securities Inc. in New York. He sees annual growth below 2 percent in the second half. The economy expanded at a 2.6 percent rate in the second quarter and 5.6 percent in the first.

Growth is getting closer to what Macroeconomic Advisers LLP President Chris Varvares describes as the ``stall speed,'' where an unexpected shock such as a terrorist strike or a hurricane might be enough to trigger a recession. A mathematical model of the economy developed by Federal Reserve economist Jonathan Wright puts the chances of a recession over the next year at about 40 percent.

With recession risks rising, some Fed officials are becoming uneasy about the outlook. While they remain on guard against the dangers of higher inflation, they say they're also paying more attention to the threats to growth.

Fed Concerns

``We are now seeing a slowdown,'' Kansas City Fed President Thomas Hoenig said in a Sept. 27 speech in Lincoln, Nebraska. ``We have various concerns around that.''

Hoenig cut his own forecast of second-half growth to between 2 and 2-1/2 percent, from the 2-1/2 to 3 percent he predicted as recently as Sept. 15.

Most economists and Fed officials still expect the economy to avoid recession, helped by increased exports and business spending. Except for housing, ``the rest of the economy is healthy and robust,'' Dallas Fed President Richard Fisher said in a Sept. 25 speech.

That's helping the standing of President George W. Bush's Republican Party as it struggles to retain control of Congress in elections that take place Nov. 7, 11 days after the government delivers its first estimate of third-quarter growth. A Bloomberg/Los Angeles Times survey published Sept. 21 showed a jump in support for Bush's handling of the economy even as growth slowed. While the pain of slower growth, such as higher unemployment, takes some time to be felt, consumers were enjoying the more immediate pleasure of a 35-cents-a-gallon plunge in gasoline prices during the prior month.

Brighter Side

Investors, too, are focusing on the brighter side. Stock prices have bounded higher, with the Dow Jones Industrial Average briefly surpassing its record closing high last week, on speculation the Fed will succeed in engineering a soft landing for the economy.

Bonds have also gained, pushing yields lower. The benchmark 10-year Treasury note yielded 4.61 percent as of 10:41 a.m. in New York today, down from 4.73 percent at the start of September. Investors are betting slower growth and easing inflation will let the Fed cut interest rates as early as next year.

``Investors are inherently predisposed to hope and pray for a soft landing,'' says Stephen Roach, chief global economist for Morgan Stanley in New York. Even so, he says, ``the odds of a recession are growing.''

Less than a month ago, most economists expected growth for the rest of the year to remain close to the 2.6 percent pace of the second quarter. The median forecast of 81 economists in a Bloomberg survey published Sept. 8 saw growth of 2.8 percent in the third quarter and 2.6 percent in the fourth.

Auto Production

Varvares says auto production cuts alone probably shaved 0.3 percentage point off third-quarter growth. St. Louis-based Macroeconomic Advisers reduced its estimate of growth for the quarter to 1-1/2 percent, from 2-1/2 percent a month ago. It expects growth to bounce back in the fourth quarter.

General Motors Corp., the world's largest automaker, is trimming North American output in the second half by 10 percent from a year earlier. Ford Motor Co. is reducing production 16 percent and DaimlerChrysler AG's Chrysler unit is cutting as much as 17 percent.

The automakers' cuts prompted BorgWarner Inc. to announce plans to reduce its North American workforce by about 850 people, or 13 percent. The Auburn Hills, Michigan-based company is the world's biggest maker of automatic-transmission parts.

Factory Index Drops

Manufacturing in the U.S. last month expanded less than economists forecast as production growth slowed, an industry group reported today. The Institute for Supply Management's manufacturing index dropped to the lowest level since May 2005.

The housing outlook is even grimmer. New-home sales in August were 17 percent below a year earlier and the median selling price was down 1.3 percent, the first year-over-year drop since 2003. Existing home sales were the lowest since early 2004, and prices fell for the first time in 11 years.

Housing market conditions ``have continued to weaken,'' Stuart Miller, chief executive officer of Miami-based Lennar Corp., the third biggest U.S. homebuilder by market value, told analysts Sept. 26. ``August might have been the weakest month yet.''

Housing-Related Industries

Housing-related industries, including builders, mortgage brokers and furniture makers, have shed some 40,000 jobs since March, says Zoltan Pozsar, an economist with Moody's Economy.Com, Inc. in West Chester, Pennsylvania. He expects the pace of layoffs to increase to 20,000 per month or more. In the 1990-91 housing slump, housing-related industries shed 825,000 jobs, or about 35,000 a month.

Countrywide Financial Corp., the largest U.S. mortgage lender, told employees in a Sept. 19 memo to expect job cuts of 5 to 10 percent in some departments. The Calabasas, California- based company, which employs 56,000, funded 24 percent fewer loans in August than a year earlier.

Consumer spending will also take a hit as falling house prices discourage homeowners from borrowing against equity gains. Home equity withdrawal fell to an annual rate of $497 billion in the second quarter, from $649 billion in the first quarter and $817 billion in the final quarter of 2005, according to calculations supplied by the Fed.

Threat to Spending

``A fall in home prices across the nation would pose a significant threat to consumer spending,'' says Joseph Carson, director of global economic research for AllianceBernstein. He expects second half growth of 1-1/4 to 1-1/2 percent, down from the 2 percent rate he saw previously.

Goldman Sachs, which cut its forecast for third quarter growth to 2 percent from 2.5 percent in early September, reckons that the decline in equity withdrawal should start weighing on consumption about now.

``The one-two punch of a slowing housing market and the large announced auto-production cuts by GM, Ford and Chrysler is really going to slow the economy,'' says Mark Vitner, a senior economist at Wachovia Corp in Charlotte, North Carolina. ``It's going to be a bit of a rough landing.''

To contact the reporter on this story: Rich Miller in Washington at rmiller28@bloomberg.net

Last Updated: October 2, 2006 10:53 EDT