Economy Hits a Speed Bump and May Dive Further
Life + Money

Economy Hits a Speed Bump and May Dive Further

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Concern the U.S. economy was heading for another summer swoon was mounting even before Friday's disappointing jobs data. Economists are increasingly predicting 2012 will be another year when growth struggles along at about 2 percent.

The United States is holding up better than Europe, where several countries have slipped back into recession. And there are signs of resilience in some measures of the economy, especially the manufacturing sector. Still, while American consumers increased their spending in the first quarter, growth in incomes is lagging, suggesting something has to give, and businesses began cutting investment earlier this year.

And uncertainty about the outcome of the presidential and congressional elections in November, coupled with the risk of a big hit from tax hikes and spending cuts set to take effect in 2013, may cause shoppers and employers to pull back. Fear hasn't quite gripped the financial markets yet. Stocks fell on Friday, but the benchmark S&P 500 remained up a healthy 9.2 percent this year. Some say that optimism is misplaced.

"You've really got to be whistling past the graveyard to think that all is jolly here," said Joshua Shapiro, chief U.S. economist at MFR in New York, a global consulting firm. Add in the risk that Europe's debt crisis deepens, which would hurt not only U.S. exports but also American banks, and annual growth of around 2 percent or less in 2012 may be the best anyone should hope for

Economists at HSBC are telling clients to brace for a repeat of 2011, when the economy started strong but fizzled as the days grew longer and temperatures rose. "Over the next two quarters, we expect that growth will average a bit less than 1 percent, reducing the year-over-year growth rate to 1.7 percent," Kevin Logan, HSBC's chief U.S. economist, wrote in a note to clients this week.

That's a worrisome prospect for just about everyone -investors, businesses and consumers, not to mention President Barack Obama, who faces a tough re-election battle.

It could also persuade the Federal Reserve, which expects growth to land somewhere in a 2.1 percent to 3 percent range this year, to launch a third round of bond buying in the hope of further lowering rock-bottom borrowing costs. The central bank has poured more than $2 trillion into the financial system already through bond purchases. That has helped lower long-term interest rates and added fuel to a market rally.

Data on Friday showed the economy added 115,000 new jobs in April, far fewer than expected on Wall Street and a further slowdown from disappointing gains in March. Employers added more than 200,000 jobs a month from December through February, leading markets to hope the economy was finally turning a corner.

Not everyone has given up hope. The consensus among Wall Street economists before Friday's report had the economy expanding at about 2.2 percent between April and June, matching the first-quarter pace. Recent data has indeed painted a mixed picture. This week alone, reports on one hand showed growth in manufacturing and a decline in new applications for unemployment benefits while on the other hand there was a sharp weakening in the service sector and the decline in hiring.

Economists at Credit Suisse said the pullback in hiring after the winter surge should come as no surprise. Indeed, many economists, including Fed Chairman Ben Bernanke, have said an unseasonably warm winter may have driven the quicker pace of hiring at the start of the year.

"We interpret this as consolidation, not the start of a prolonged slowdown," Credit Suisse said of Friday's data in a note to clients. "Real private demand, which is a leading indicator of payrolls, has not in fact turned down."

JPMorgan economist Bruce Kasman conceded on a conference call on Friday that the economy was going through a soft patch but said he expects job gains to average 200,000 per month for the year and the economy to expand by 2.5 percent. Still, even at a rate of 250,000 new jobs a month, it would take about eight years to roll unemployment back to the 5 percent rate that prevailed at the end of 2007.

"We're not looking for the U.S. to drift into recession, but we expect weak hiring and uninspiring growth," said David Semmens, U.S. economist at Standard Chartered, who expects growth of 1.7 percent this year. "It will take a long time to get back to where we'd all like to be."

One reason the economy may struggle, according to Neil Dutta, U.S. economist at Bank of America-Merrill Lynch, is that wage growth simply isn't keeping pace with consumer spending. Adjusted for inflation, personal income grew at a slender 0.4 percent rate in the first quarter, while consumer spending, which accounts for about 70 percent of economic activity, rose 2.9 percent.

That means consumers are not doing much saving, which can't continue if incomes remain stagnant, he said. Likewise, Dutta expects firms to restock shelves at a slower pace in the second quarter. "And the risk is that export growth will keep slowing in ensuing quarters because we've yet to feel the full impact of the recession in Europe."

To complicate matters further, a host of temporary tax cuts on income, dividends, payrolls and capital gains are set to expire on January 1, the same day automatic spending cuts would come into effect and extended unemployment benefits would end. This "fiscal cliff" poses a big threat to the economy. If Congress does nothing, Nomura Securities estimates the measures could drain more than $1 trillion of stimulus from the economy, enough to plunge America into recession.

Russ Koesterich, global chief investment strategist at iShares, said markets are not panicking yet. "People are worried but they feel some sort of fix will get done."

However, BofA's Dutta fears the uncertainty will prompt firms and households to cut spending as the year goes on. Likewise, he said investors fearing tax hikes may opt to take their profits early, which could stop the stock market rally in its tracks. "People don't board up their houses for hurricane season," he said, "but they do board up their houses when a hurricane warning is issued."

Even if Congress avoids the crunch this year, some fear slower population and labor force growth will eventually require tax hikes to pay growing pension and social welfare costs. That could mean many more years of sluggish growth, said David Resler, U.S. economist at Nomura Securities.

"I'm increasingly of the mind that the last two years are a precursor of what the next 10 will be like," Resler said. "That's an alarming thought, because we need growth to fix most of the problems we have."

(Additional reporting by Stella Dawson in Washington)