It seems like déjà vu. A year ago, fears about prospects for the U.S. economy mounted as fiscal trauma in Europe and financial turmoil in the markets were on everyone’s radar screens. By late summer, the Federal Reserve became so worried about the likelihood of the U.S. slipping back into recession and facing deflation that it looked for ways to come to the rescue. This culminated in a massive program to buy $600 billion of Treasury securities, nicknamed by the markets as “QE2”.
The debate is now whether the U.S. economy has just hit a “soft patch” or whether the fundamentals are shifting to a much lower or even negative gear. The answer will have profound implications for business sales, commodity prices, jobs, stock prices, and politics.
There are certainly some underlying forces that are likely to keep a lid on growth in the period ahead. A large number of troubled mortgages means that home prices will not be able to bounce back quickly even with low interest rates and improved affordability. The history of recessions caused by financial crises also suggests that subsequent recoveries are typically relatively slow.
Yet, some of the recent weakness in the economy is due to temporary factors that are likely to be at least partially reversed in the second half of 2011. Japan’s earthquake, tsunami, and energy cutbacks have disrupted supply chains, notably in the auto industry. The surge in energy prices also cut into U.S. consumers’ buying power. Wet weather in April, followed by tornadoes and flooding in May and June, have contributed further to economic misery.
Stellar growth is unlikely to appear in the second half of 2011, but we should see improvement. Auto production will expand significantly to rebuild inventories, while Saudi Arabia’s move to increase production should bring some relief in terms of oil prices. The Federal Reserve is unlikely to launch another massive purchase of Treasury securities, but it also can be expected to keep its short-term interest rate target close to zero. Greece will probably see another “bailout” package rather than be allowed to default. China and the other emerging markets should still see sizable growth as policy officials avoid slamming on the brakes too aggressively.
The U.S. economy will reach the second anniversary of its recovery at the end of this month. Real GDP (gross domestic product) has been growing at an annualized pace of about 2.8% over the past two years. Growth in the second half of 2011 should average around 3.5%. While moderate by historical standards, this should be enough to create more jobs and drive the unemployment rate gradually lower. Most commodity prices should see a modest firming, while stock prices move erratically higher.
The economy and markets rarely move in a straight line. Try not to overreact to each data point.