Forecast: On again, off again economy could last for years

McClatchy NewspapersJune 2, 2011 

WASHINGTON — When the federal government releases its closely watched May jobs report on Friday, it's likely to raise more concerns that the U.S. economic recovery is losing steam. What's not clear is whether this signals a temporary slowdown or something more ominous.

All eyes will be on the Labor Department. Its monthly employment reports are economic indicators that point backward, but they also help cement expectations of the future. The past two monthly jobs reports showed robust hiring, but Wednesday's ADP National Employment Report, which measures private-sector payrolls, pointed to a sharp downturn in hiring.

That's but the latest disquieting note in a quickly developing trend; all kinds of other economic indicators are also pointing to a slowdown. This week alone data on manufacturing, car sales, home prices and unemployment claims all pointed to a weakening economy. But how weak, and for how long? Forecasters aren't sure.

On top of that, Washington is unlikely to do anything more to spur the economy. There's little appetite in Congress for more government spending; in fact, all the momentum there is toward cutting spending in the name of debt reduction.

In addition, at the end of this month, the Federal Reserve will end its unprecedented $600 billion purchase of government bonds. It was intended to lower bond interest rates and thus stimulate financial markets by spurring investors out of safe bond havens and into more risk taking, such as stocks. Ending the Fed's program removes that stimulus.

All this has led forecasters to lower their projections for near-term economic growth. Macroeconomic Advisers dialed back its 3.5 percent growth projection for the second quarter of 2011, dropping it to 2.7 percent on Wednesday, then another notch down to 2.6 percent on Thursday.

Few economists predict a return to recession, yet many are increasingly concerned that the slowdown may be growing worse.

"There's a certain trepidation right now that there wasn't a month ago," said Steven Ricchiuto, chief economist for Mizuho Securities USA Inc. "A month ago, people thought the end of QE2 (the Fed's bond-purchase program) would be no issue. People are a little bit more worried that this is a repeat of last year, and to be honest with you, it is a very difficult question to ascertain at this juncture."

Last year, the economy hit a soft spot in spring, and the Federal Reserve stepped in with an aggressive plan to purchase $600 billion in Treasury bonds, a move credited with sparking life into financial markets but also blamed for driving up the price of crude oil and a range of agricultural commodities.

Fed Chairman Ben Bernanke suggested in a rare April news conference that the bar would be awfully high for another round of bond purchases, and some analysts fear that the Fed may be out of bullets. After all, its benchmark interest rate has been effectively at zero since late 2008, so cutting rates further isn't an option.

Laurence Meyer, a former vice chairman of the Fed, doesn't think the central bank is out of bullets, but he acknowledges that the economy is in a rough spot.

"It's complicated because we can identify temporary factors that slowed the growth in the first quarter quite a bit. The supply chain effects (from Japan's natural disaster) clearly seem to have slowed second-quarter growth," Meyer said in an interview. "But it does seem like the U.S. and almost every place you look around the world has slowed, so there is a more fundamental loss of momentum, not only in the U.S., but all around the world."

Although the Fed cannot lower rates further, he said, it could signal to markets that rates won't rise for a longer period than now expected. That would create an expectation of cheap borrowing costs over a longer horizon and help boost long-term investments.

Additionally, although the Fed this month will hit the zenith of its bond purchases, that's precisely when the program's supposed to have its biggest spark for the economy. It will serve as a tailwind against the headwind factors that are slowing growth.

"Stimulus is measured not by the rate of (bond) purchases, but by the level of assets on the Fed's balance sheet," Meyer noted, saying the purchases should be akin to cutting rates, already at zero, by another half a percentage point.

In addition, even though the Fed is halting its purchases, it continues to reinvest its earnings from the holdings, providing continued spark, said Meyer, now vice chairman of Macroeconomic Advisers.

For Meyer and other economists, the next important signposts will be Friday's jobs report, then the next report on durable goods — big-ticket items such as refrigerators_ and data on international trade. Imports, primarily higher priced crude oil, offset the gains made by U.S. exports and have lowered the U.S. growth rate.

Some causes of the slowdown are clear. They include high energy prices that have more than sucked away any benefit from this year's payroll tax holiday. Soaring pump prices have eaten into consumer spending, and consumption drives more than two-thirds of economic activity.

The continued slide in home prices is also limiting people's mobility and dampening their appetite to consume as they see the value of their most important asset continue to drop.

"We've got to be careful about hoping this is going to be a consumer-led economy as in the past," warned Michael Hanson, an economist with Bank of America Merrill Lynch in New York.

Consumers also have less access to credit than in the past, and they cannot count on their homes to create wealth for them as they did in recent years, he said.

The hard fact may be that the U.S. economy is going to grow in fits and starts for several years, said Vincent Reinhart, the former top economist on the Fed's rate-setting Open Market Committee.

"Economies grow more slowly after a financial crisis. The unemployment rate stays persistently high, and house prices tend to keep declining well into an (economic) expansion," he said. "We're pretty much following that path."

Together with his wife, Carmen Reinhart, a prominent economist, the former Fed official published research last summer that showed that the U.S., despite its status as the world's leading economy, is following the script of other nations that suffered through a severe financial crisis.

"We also tend to react so that 'it' never happens again. So we require banks to hold more capital, we put in more regulation and we raise the cost of doing business," he said. "We accumulate a lot of debt during the crisis, and that slows economic recovery."

Indeed the gross national debt, now at its ceiling of $14.3 trillion, factors squarely into the question of whether this is a soft patch for the economy or begins a slide back into recession. If steep immediate cuts in federal spending accompany the expected rise in the debt ceiling later this summer, that could further weigh down a slowing economy.

It all points to a long slog still ahead.

"People got sucked into belief that one quarter is a trend. The economy is doing the best it can given underlying conditions," said Ricchiuto of Mizuho Securities. "I'm not sure policymakers can jumpstart the economy ... it's the post-crisis workout period. There's a lot of uncertainty."

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