America’s economy battles uncertainty

The economy

Downdraught

America’s economy battles uncertainty, both home-made and imported

WASHINGTON, DC |

THE much-vaunted recovery began to show signs of slowing a few months ago. Even so, the revelation on June 1st that employment grew by just 69,000 in May, a 12-month low, suggested a more serious deceleration than anyone had imagined. The stockmarket plunged, giving up all its gains since January. Online punters slashed the odds that Barack Obama would be re-elected to a little over 50%.
As recently as February payroll growth was running at 250,000 a month. Many of the headwinds that had held back growth for so long were abating. State and local government lay-offs have eased, and housing, though deeply depressed, has been reviving: both sales and construction of new homes are rising, as are prices, by some measures.

The abrupt reversal of mood recalls both 2010 and 2011, when a promising burst of growth in the early months petered out in spring and summer. Last year the culprits were obvious: Libya’s turmoil had sent petrol prices sharply higher, Japan’s tsunami disrupted supply chains, and over the summer politicians flirted with defaulting on the national debt.
The sources of this year’s weakness are harder to identify. Petrol prices are up, but by much less than last year. Other economic data have been mixed: gross domestic product grew by 1.9%, annualised, in the first quarter, and economists think it is growing a bit faster in the current quarter. Private surveys of purchasing managers showed both factory and service activity holding steady in May. And even as job growth has slowed, unemployment has trended lower. The slight increase in May, to 8.2% from 8.1% in April, was caused by more people bothering to look for work, a welcome reversal from previous months.
The weather is partly to blame. An unusually warm winter pulled forward some hiring that normally occurs in the spring. Construction employment, for example, rose by 45,000 in the three months through January, and has since fallen by 48,000. Inventories are another factor: firms appear to have slowed the pace at which they are adding to stocks in the current quarter. As those temporary factors fade, and as consumers get the benefit of a recent drop in petrol prices, job creation may still rebound.
Yet hopes that 2012 would be the year when America’s economy at last shook off its lethargy seem dashed. Employers and investors face increasing uncertainty in every big economy. China, India and Brazil have slowed sharply. The euro zone is dangerously close to collapse. Goldman Sachs reckons that the spillover of European stress into American financial markets will knock 0.2 to 0.4 percentage points off growth this year.
Meanwhile, tax increases and spending cuts equal to 5% of GDP a year are programmed to take effect around December 31st. Most analysts assumed this “fiscal cliff” would not be a worry until 2013. But economists at Bank of America, in a recent report, think it could become a significant drag relatively soon. The fiscal hit is huge, the date is set, and no resolution is in sight before the election on November 6th . This all gives firms a powerful incentive to postpone hiring and investment until the resolution is known. The bank sees a one-in-three chance of recession between now and mid-2013.

In the past week both Bill Clinton and Larry Summers, Mr Obama’s former principal economic adviser, have urged early action to avoid the cliff. Without such action, the only source of support is the Federal Reserve. When the economy faltered in 2010 and 2011 it responded, first, with a second round of bond purchases paid for by creating money (“quantitative easing” or QE), then by buying long-term bonds in exchange for short-term ones, a move called “Operation Twist” (see chart). Buying bonds pushed their prices up and yields down. The Fed has also promised to keep interest rates near zero at least through 2014. And, until recently, it was not inclined to do any more than that. However, the present weakness in employment, the growing risks coming from Europe, and the fiscal cliff all suggest the Fed will give serious thought to easing monetary policy at its meeting on June 19th and 20th. Janet Yellen, the Fed’s vice-chairman, said on June 6th that although she still expects a gradual decline in unemployment and stable inflation, there are “significant downside risks to the economic outlook, and hence it may well be appropriate to insure against adverse shocks.”
How the Fed might ease again remains unclear. It could promise to maintain interest rates near zero beyond 2014, its current commitment. Ms Yellen, however, suggested that that would have only a limited effect. Several officials favour more QE, the Fed’s most powerful tool, though some fret about potential side effects, such as rising commodity prices and a political backlash. The Fed could extend Operation Twist: the stash of one-to-three-year bonds it could trade for longer-term issues has dwindled, but it still has plenty of three-to-six-year paper. On the other hand, Macroeconomic Advisers, a consultancy, warns that selling such bonds could put upward pressure on consumer loan rates.
Then there is the question of what more bond-buying would achieve. Long-term Treasury yields are already down to 1.7%, near the lowest ever recorded. Yet while its tool-kit may be less powerful, at least the Fed seems able and willing to use it. The same cannot be said of either the euro zone or Congress.