Optimism over US economy but dangers lurk in background

Written by The Financial Times | Updated: Dec 31 2011, 07:18am hrs
By James Politi in New York

When Federal Reserve officials met in mid-December for their last gathering of the year to set monetary policy, they offered a hint of optimism about the resilience of the US recovery.

The economy has been expanding moderately, notwithstanding some apparent slowing in global growth, they said.

After dodging a series of bullets over the course of 2011 - both from external shocks such as the eurozone debt crisis and domestic factors such as the downgrade of the US credit rating by Standard & Poors - the US economy is entering the new year on more solid ground.

Gross domestic product growth could well exceed 3 per cent on an annualised basis in the fourth quarter, according to forecasters, which would be the strongest reading since the second quarter of 2010 and well above the 1.8 per cent growth rate in the third period.

After fears that job growth had stalled over the summer, businesses have created more than 150,000 positions every month on average since September. New applications for jobless claims ticked up this week, but the four-week moving average of 375,000 is the lowest since mid-2008.

These data are consistent with a relatively sluggish and subpar recovery that will struggle to bring down Americas 8.6 per cent unemployment rate, but offer greater confidence that the economy is less vulnerable to sliding backwards than it appeared to be.

Were finishing the year on a solid note, particularly in relation to the rest of the world, said Alan Ruskin, an analyst at Deutsche Bank, who believes a key question for 2012 is whether the US can continue to insulate itself from economic problems elsewhere. So far so good, Mr Ruskin said.

US consumers, too, have become more bullish on their prospects and started spending more aggressively. The Conference Boards index of consumer confidence jumped in December to 64.5 from 55.2 in November, and chain store sales during the holiday shopping season were above economists expectations.

There is nothing in the current economic performance to really dislike, said Steven Wieting, an economist at Citigroup.

But while this marks a contrast to the much bleaker outlook just a few months ago, there is also little certainty the US economy is completely out of danger. The biggest concern is that the eurozone sovereign debt crisis could flare up again and inflict much more severe damage to the global financial system - including US banks and the supply of credit to US consumers and businesses - than it has so far.

Domestically there remains considerable uncertainty over the US fiscal trajectory, with Republicans and Democrats in Congress mired in partisan warfare over virtually every move on taxes and spending. In the most recent bout of brinkmanship, the US extended a payroll tax cut for workers and jobless benefits last week - but only until the end of February. Economists at IHS Global Insight are estimating that if Congress cannot reach a deal to extend these for the rest of 2012, it would put a drag on US GDP growth of about half a percentage point.

With growth still expected to be 1.5-2 per cent next year, IHS says this would have dramatic consequences. Potentially even more worryingly over the long-term is the severe fiscal tightening that is scheduled to start in 2013 unless politicians in Congress find a way to overcome their differences.

The expiring of Bush-era tax cuts that would save more than $3tn for the government over 10 years, and $1.2tn in automatic spending cuts to domestic and defence spending, are both expected to kick in from January 2013.

Finally there is the housing market, which has never recovered from the sharp downturn that triggered the financial crisis in 2007 and continues to be the US economys Achilles heel. After levelling out over the summer, house prices are falling again - raising concerns that the collapse has not fully run its course.

According to S&Ps Case-Shiller index, seasonally adjusted home prices were down in October by 0.6 per cent in the 20 largest US cities and down 3.4 per cent compared with a year earlier.

But in housing, too, there seems to be a glimmer of hope. Pending home sales rose 7.3 per cent in November to the highest level since April of 2010, according to the National Association of Realtors.

The Financial Times Limited 2011