"I am apprehensive" about what the February nonfarm payrolls report will show, the official said. "I am preparing myself for a bad report," Lockhart said.

The official was responding to reporters' questions following a speech before the Greater Miami Chamber of Commerce.  As reported by Dow Jones News

With the economy likely to shrink significantly in the first half of this year, the unemployment rate rising higher than 8.5 percent is, unfortunately, very likely.
...
I believe that below-potential growth is likely to persist until financial markets and financial institutions can resume more normal functioning.  So in addition to the other steps being taken to stimulate the economy, we need to be sure that actions to support the stability of the financial system are taken without delay – and, in the slightly longer term, that regulatory frameworks are thoughtfully reformed.

The near-term economic outlook is not encouraging. The incoming data in September and October have been worse than expected, and these results pushed my staff and me to revise downward the Atlanta Fed's outlook for the economy.

I foresee substantial weakness at least through the first half of 2009. This weakness will exacerbate the employment picture. In my outlook, unemployment will rise some more.

If there is anything positive in this near-term outlook, it is the trajectory of prices. I expect headline inflation to decline over the coming months and fall into an acceptable range below 2 percent by 2010. Over the longer term, inflation experience is influenced by inflation expectations. Encouragingly, the University of Michigan consumer survey's reading for October shows a moderation in inflation expectations both for the year ahead and for the longer term.

As noted earlier, the rapid rise in delinquencies for home equity lines and junior liens held at banks is occurring despite an unemployment rate of about 5 percent – so, should the unemployment rate rise and housing prices continue to fall, financial stresses caused by the housing correction could well spread beyond the large banks involved in complex securitizations, and the smaller banks with sizeable portfolios of construction loans, to a larger set of financial institutions. 

With the unemployment rate currently at 5 percent, it is a little above my estimate of its sustainable level, and the sluggish  performance I expect this year is likely to push unemployment up further.

``The economy is growing far less than its potential,'' Hoenig [said]. The U.S. can expand at 2.5 percent without creating inflation, versus the 0.6 percent annual rates of the last two quarters, he said. ``When you're that much below potential, people are losing their jobs and the economy isn't creating as much wealth as it should.''

As reported by Bloomberg News.

 In fact, the contraction in spending on housing construction subtracted a full percentage point from U.S. real GDP growth last year, and nearly as much the year before. It seems likely that this sector will be a major drag on the overall economy through the end of this year and into 2009.

Until recently, the deflating housing bubble had not spilled over to the rest of the economy. But now it has. It appears that growth in consumption and business investment spending has slowed markedly after years of robust performance, and, as a result, the economy has all but stalled and could even contract over the first half of the year.

The factors weighing down consumer spending go beyond the effects of the credit crunch and the falling house prices. Consumers also face constraints due to the declines in the stock market, which have diminished their wealth. Furthermore, energy, food, and other commodity prices have risen sharply in recent years, essentially “taxing” their incomes. Finally, and very importantly, labor markets have weakened.

With stimulus from monetary and fiscal policy, economic performance should improve in the second half of this year. Nonetheless, the economy is still likely to turn in a sluggish performance for the year as a whole. With the unemployment rate currently at 4.8 percent, it is still about in line with my estimate of its sustainable level. But the weak performance I expect this year is likely to push unemployment into a range indicating the presence of some slack.

The potential for headwinds is integral to thinking about economic prospects over the next year or two. To the extent that these headwinds gain momentum, they suggest relatively modest growth for a time and the likelihood of increases in the unemployment rate. Their implications for inflation are not so clear, although I would note that the pace of inflation diminished in the early 1990s relative to its performance over the preceding several years.

While identifying housing as still a key drag on the economy, he warned, "We must not allow our concern about 5% of the economy to screw up the other 95% of the economy." 

"Consumer debt, putting mortgages aside, is not likely to be a serious issue unless we have a serious rise in unemployment," he said.
"If we get a big decline in employment then there will be further shoes to drop."

From Q&A as reported by Market News International

There is a fair amount of month-to-month volatility in the employment numbers, so it is quite possible that the underlying trend is stronger than the January reading by itself would suggest. If job growth is positive in the months ahead, and if wages can stay ahead of inflation, then income growth should be sufficient to support consumer spending gains and allow us to skirt the boundary of recession.

Recent employment data affected many observers' assessments of the risks to the economic outlook. Moreover, analysis by my staff suggests that the employment picture for 2007 was weaker than recent statistics indicate.

To sum up the story on the outlook for real GDP growth, my own view is that, under appropriate monetary policy, the economy is still likely to achieve a relatively smooth adjustment path, with real GDP growth gradually returning to its roughly 2½ percent trend over the next year or so, and the unemployment rate rising only very gradually to just above its 4¾ percent sustainable level.    

[O]ur baseline forecast sees soft economic activity this fall; notably, it is likely that a further sharp decline in residential investment will weigh on the top-line growth numbers. But we see growth recovering next year and moving up to average close to potential later in 2008, which we at the Chicago Fed currently see as being somewhat above 2-1/2 percent. This lower potential number in part reflects an assumed trend in productivity growth that is slower than the trend we experienced over the 1995-2003 period. Nonetheless, the new productivity trend is still a healthy one by longer-term historical standards and, accordingly, should support income creation, job growth, and household and business spending. Solid demand for our exports should also be a plus for growth. Although we expect a small increase in the unemployment rate, labor markets in general should remain healthy. Indeed, on balance, I would characterize the data we have received on the real economy since the last FOMC meeting as supporting our baseline forecast.

The financial market turmoil that began in August hit hard an already struggling housing market. Financial markets appear to be stabilizing, but they have not returned to normal and are still fragile. Most forecasters have reduced their expectations for GDP growth and believe that downside risks have risen. However, the employment report for September, the latest available at this time, does not suggest that the downside risk is occurring. As an aside, the substantial upward revisions to data released in the August report remind us that it is a mistake to place too much weight on any one report.