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It appears unavoidable that the turmoil in financial markets amid the ongoing housing decline will drag the economy into a recession. The fourth quarter, which just began, will show contraction as both business spending and consumer spending retreat. The first quarter of 2009 likely will continue the contraction before improvement in the spring. Rising unemployment in 2009 will dampen consumer income and spending so that even when growth resumes, it will be subpar. Look for GDP to increase slightly less than 1% in 2009, following a weak increase of about 1.5% this year. Exports won't be as strong next year but will increase.

The Federal Reserve likely isn't finished cutting interest rates. With the economy expected to weaken over the course of the fourth quarter, more cuts will come, possibly as soon as the Oct. 28-29 meeting of the rate-setting Federal Open Market Committee. The problem is that this path, while helping some consumer and business borrwers, isn't getting the typical applause from investors. That's because the big problem in credit markets isn't the cost of borrowing but actual lending. Banks and investors are afraid and therefore unwilling to take any chances. Many are putting their cash in short-term Treasuries. So it's other actions by the Fed that will improve the situation, such as its announcement Oct. 7 that it will become a buyer in the $1.6 trillion commercial paper market. In any event, look for the Fed to cut another half point by yearend, and banks will follow, lowering the prime rate to 4%. As for long-term rates, investors eventually will reverse their flight to safety and begin to focus on the huge additions to the U.S. budget deficit resulting from efforts by the Treasury to buy mortgages and mortgage-backed debt held by banks. As a result, the 10-year Treasury will rise to about 4.25% by the end of 2009. The 30-year fixed-rate mortgage will stay mostly between 6% and 6.25%.

A vicious cycle is developing in the job market. More businesses, seeing orders and sales slow, are turning cautious and laying off workers. That's been the case in manufacturing, and it's now spreading into the service sector. As layoffs increase, incomes shrink and so does consumer spending, inducing firms to continue cutting payrolls. There are exceptions, but not many, with gains in health care, mining and government. Making conditions worse are tighter lending standards by banks and a virtual freeze for companies that need to borrow through the commercial paper market. As a result, 760,000 net jobs have been lost so far this year, and look for employers to shed more jobs before conditions start to improve in 2009. The unemployment rate, now up to 6.1%, will rise to 7% next year. That rate is disturbing, but it remains well below the 8% to 10% peaks posted during previous recessions.

The retreat in energy prices is finally showing up in the Consumer Price Index. After a CPI surge of 1.1% in June and 0.8% in July, the index fell 0.1% in August. The Labor Department said prices also eased for new cars, hotel rooms and apparel, though increases did occur in medical care and recreation. The CPI as of August is up 5.4% over 12 months, but the pullback in energy prices will result in an increase of 4.5% this year and about half that pace in 2009, as measured from December to December. One sour note: Food prices, up 6.1% over the past 12 months, are likely to stay around that level for some time. The core CPI, which excludes food and energy, has gone up 2.5% over the past year and likely will be a tick or two lower in 2009. The weak economy will make it tough for businesses to raise prices, while elevated unemployment will hold wage pressures in check.

The housing market continues to lurch toward a bottom. Existing-home sales appear to be leveling off, at or slightly below 5 million annualized. New-home sales and housing starts, however, continue to tumble and likely will level off next spring or early summer. But, after they've hit a bottom, don't expect much of a rebound as sales and starts will be pretty much flat in 2009. Meanwhile, foreclosures will continue to increase in 2009, dampening home prices, particularly in Florida, Southern California, Nevada and Arizona. At the same time, price gains are showing up in Atlanta, Boston, Dallas and Denver. Overall, the national average price will decline abut 5% in 2009.

We see oil averaging about $100 a barrel in 2009, down from the $115 average for this year. Expect prices to seesaw, though: Crude oil will be pummeled for months by the wave of selling on Wall Street of stocks and commodities in every sector. This will be sorted out, but look for wild price swings along the way, with oil bobbing as low as $85, although a plunge to $50 isn't in the cards. The Organization of the Petroleum Exporting Countries would throttle back production at the first hint that crude prices were headed below $90. By next spring, oil prices should rise to $125 a barrel or so, as automobile and trucking demand reach seasonal peaks.

Oil supplies will remain fundamentally tight, and a multitude of supply risks around the world will prevent prices from plunging. Ongoing slow growth or declines in most industrialized nations will likely limit growth in demand for crude to around 1.5% in 2009, in line with this year's 1% growth. An ongoing phaseout of fuel subsidies in several Asian nations will help temper demand. Oil supplies will expand at around a 2.5% clip in 2009, year over year.

Gasoline prices should average around $3.40 per gallon in 2009, around 20˘ a gallon less than this year. For diesel, expect to pay an average $4.15 per gallon, or 15˘ less than this year. Retail heating oil prices should also average $4.15 per gallon, 15˘ less than in 2008, while natural gas will be around $10.50 per million British thermal units, unchanged from this year. Propane prices should average $2.90 a gallon or so, up 15˘. Gasoline use should rise a bit in 2009 compared with this year, which will see purchases fall by as much as 3.5%. It will be the first decline since 1991, when gas prices jumped as the U.S. entered the Persian Gulf War.

Weak U.S. demand in 2009 will shrink the trade deficit for the third year in a row. The deficit will come to less than $450 billion or 3.2% of U.S. gross domestic product (GDP). That's the smallest trade gap relative to GDP since 1999. Imports will expand by roughly 1.5%, after contracting more than 1% this year. Exports will continue to leave them in the dust with 7% growth, compared to more than 8% in 2008. Solid sales to Asia, excluding Japan, and to Latin America will more than make up for anemic growth in Canada, Japan, the euro zone and the United Kingdom. The dollar, though it has strengthened somewhat is still relatively weak, and should continue to help exporters by making U.S. goods more affordable and more competitive on world markets.

Retail sales growth will slow to just over 1% in 2009 after gaining 2% this year. The biggest forces holding shoppers back continue to be expensive fuel -- despite recent price declines -- and worries about home values and income security. Making matters worse, manufacturers and retailers are out of options and will try more aggressively to pass along high costs for shipping and commodities. One-stop discount destinations, such as Wal-Mart and Target, will continue to draw more shoppers as consumers keep a watch on how many miles they drive and seek out value.

Meanwhile, high gas prices and job woes will limit growth in this year's back-to-school season to a sluggish 1% or less. The dreary fall will extend into the holidays, when sales will grow a bit over 2%. Sales via the Web will continue their torrid increases, climbing 15% in 2008 to around $200 billion and capturing 10% of retail sales, up from about 9% in 2007. Consumers are becoming increasingly comfortable with buying products online, while many retailers are upgrading their Web sites to attract more buyers.