The chairman of the Federal Reserve, Ben Bernanke, disappointed investors yesterday by issuing a “stay the course” message — a popular theme of the Bush administration.

Rather than suggesting that recent stock market gyrations and a weakening housing industry could prompt the Fed to ease, he stayed the course with his forecast of an economic rebound later in the year. Consequently, the expected market bounce was tepid, with the Dow Jones indicator only ahead 52 points at the close after the 416-point drop on Tuesday.

None of this surprises Wall Street’s perennially top-ranked economist, Ed Hyman. ISI Corp., Mr. Hyman’s firm, sent out a message to clients on Monday titled, “Looks Like the Economy Is Slowing.” Introducing the piece, Mr. Hyman wrote, “Our forecast for the rest of 2007 is for 2% growth versus the consensus of almost 3%.” He went on to review some of the reasons the firm’s view is so far off the consensus.

These include a downdraft in the purchasing managers index and an index reflecting small business optimism; a weakening trend in demand for temporary employment; a deceleration in year-overyear gains in payroll employment; a drop in earnings growth to 4.1% in the first quarter for the S&P 500; weaker gains in retail sales; slowing capital expenditures, and a decline in leading and coincident indicators.

Apparently, not everyone read the memo. A weak durable goods report was one of the triggers for the sharp market sell-off on Tuesday, as Wall Street reacted to the visible sign of an American slowdown.

Mr. Hyman also has been predicting a financial crisis. In his view, the 90 global central bank rate increases in the past 12 months were almost guaranteed to create a crisis; history tells us so. He has been looking for a crisis in the American subprime mortgage market or in the emerging stock markets. Who knew we might have both?

The good news is that Mr. Hyman is still rather upbeat. “The odds of a recession are very, very low; the economy looks pretty good,” he says. “If it begins to look worse — if capital expenditures and the consumer soften, the Fed will ease.”

In line with this view, the ISI group called Tuesday’s sell-off a correction, not a change in trend. They caution, however, that increased volatility may persist.

Despite this reassuring stance, Mr. Hyman does not have total confidence in Mr. Bernanke. “The Fed has become a truly hawkish institution. Until they are sure that growth is slowing, they will not be satisfied,” he says.

In other words, the Fed could well overshoot. “The mortgage markets are going to tighten further, and the impact will widen,” Mr. Hyman says. Specifically, he thinks the news today that Freddie Mac will no longer buy subprime mortgages is another indication that the government is going to crack down further on lending practices. He is worried that eventually it will be difficult even for buyers with good credit to obtain a mortgage.

Mr. Hyman points out that big drops in housing starts have always led to significant economic slowdowns. Further alarms for the sector are sounded by the drastic drop in mortgage equity withdrawals, a collapse of more than $500 billion since the peak level in 2005. This reality was evident yesterday morning, when despite some bounce in the overall market, homebuilding stocks fell further.

The risks also include a drop in employment, which is, according to Mr. Hyman, what the Fed wants. Only with some slackening of labor markets will the Fed be entirely convinced that inflation is under control. With most commodity prices easing, wages may represent the single biggest inflation threat.

Ironically, if Mr. Hyman is correct that the economy is not heading into a recession, a financial crisis — originating outside America — will likely have a positive impact on American stocks. Mr. Hyman uses as reference points the Mexico crisis in 1995 and the Pacific Rim crisis in 1997. In the aftermath of both those meltdowns, brought on by Fed tightening cycles, the stock market took a hit, and then proceeded higher. The China sell-off could well turn out the same way.

“History tells us that if China were to hit a soft spot, it could be very good for U.S. markets,” Mr. Hyman says.

Meanwhile, the sharp sell-off in China’s stock market appeared to have little to do with economic conditions in that country, and all to do with speculation and profit taking. ISI reports that recent data from the ports of China indicate continued strength, with throughput in Shanghai, for instance, ahead 26% in January. The team in China concludes that there is no evident correlation between the stock market and economic performance in China.

One item in The New York Sun yesterday caught my notice. A story from the Daily Telegraph quoted the Chinese prime minister as promising to maintain “socialism for 100 years” and playing down the possibility of moving further toward a free-market economy. Is it any wonder the market sold off?

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