Once Wall Street’s sugar high wears off from the additional measures the Federal Reserve announced this week, a harsh reality remains: Several economic indicators are flashing worrisome signals, and a slowdown in growth is expected for the rest of the year.
The slowdown comes in part from factors that are hard to control. The European debt crisis continues to muddle along, and the growth of China – the world’s other economic engine, along with the United States – is slowing faster than anyone expected. Additionally, the deep drought that plagued the U.S. Midwest over the summer may shave off more than half a percentage point from economic growth, according to government and private economists.
And some of the slowdown is a self-inflicted wound brought by the nation’s politicians. Congress remains unable to agree on what to do about tax cuts that are set to expire at year’s end or about scheduled deep reductions in most government programs if a budget deal can’t be reached. These coming cuts are known in shorthand as the fiscal cliff.
Taken together, these factors seem to suggest that the Fed’s strong action Thursday was really designed to create as much tail wind as possible for the turbulent skies ahead.
“There are a lot of head winds right now that are affecting the economy,” Fed Chairman Ben Bernanke said Thursday in a news conference after the announcement of new actions to stimulate the economy. “There’s fiscal head winds. There’s international factors, including the situation in Europe. There’s factors arising from still-impaired credit markets, and so on.”
Bernanke acknowledged that several presidents of Fed banks around the country had told him during meetings this week that employers in their districts are curtailing hiring because of the uncertain political situation.
“And I think it is a concern. It is something that is affecting behavior now. But, again, I don’t know – I don’t have a number, I don’t know how big that effect is,” the Fed chief said.
It’s one reason the Fed acted boldly, sending financial markets soaring Thursday with an unexpectedly aggressive announcement that it would launch a third round of controversial mortgage bond-buying – called quantitative easing – and extend existing Treasury bond purchases in an open-ended fashion.
The Fed is concerned that the unemployment rate is stuck around its current level of 8.1 percent. Bernanke hopes that by snapping up mortgage and government bonds, he’ll force risk-taking elsewhere in the economy and influence the lending rates for long-term loans for things such as homes, condos, cars and boats.
The move isn’t a panacea, he warned, and it’s designed to spark the economy while politics and international events are weighing against growth.
Friday brought additional indicators of continued sluggishness. The Fed released its monthly index of industrial production, showing it fell by 1.2 percent in August, including a drop in manufacturing output of 0.7 percent in just one month. That’s important because production has been a bright spot in the recovery.
“It is clear that the global slowdown has caught up with domestic manufacturing. Export orders are declining as the (unofficial) eurozone recession deepens and growth slows markedly in emerging markets,” Erik Johnson, a U.S. economist for forecaster IHS Global Insight, wrote in a note to investors. “Domestic demand has faltered, too, as concerns over the policy outlook in Washington mount. There is little evidence to suggest that a turnaround in the manufacturing sector is imminent.”
A day earlier, the Manufacturers Alliance for Productivity and Innovation released its quarterly report, which showed a sharp deceleration in manufacturing activity. After surging at a 10 percent annual rate in the first three months of this year, manufacturing slowed to a growth rate of around 1 percent from April through June, the group said.
The alliance now expects industrial production to grow at an annual rate of 4.5 percent for all of 2012 – down from earlier forecasts of 5.2 percent – and production growth of just 2.3 percent next year.
“The outlook is for modest growth through the remainder of this year and a gradual increase in 2013, but it will not be until the second half of 2014 that the economy will grow at what could be called a moderate pace,” Daniel J. Meckstroth, the group’s chief economist and the author of the analysis, wrote in the report. “Consumers continue to deleverage from debt and therefore can only increase spending commensurate with after-tax income adjusted for inflation.”
In other words, there isn’t a lot of consumer demand, and after taxes and inflation take a bite out of a paycheck there also isn’t much left for other spending.
Global events also weigh on the economy, which remains subpar despite being three years removed from recession. Chief among them is the debt crisis in the European Union.
The Europeans dodged a major threat Wednesday when a court in Germany, the backbone of the EU, ruled that the nation’s support for a European bailout fund was constitutional. But the court also ruled that any expansion of the fund beyond its current size, which most economists view as inadequate, would require German leaders to get approval from their parliament.
“That would be an interesting meeting,” Robert Rubin, the U.S. treasury secretary during the Clinton administration, said in a conference call with reporters Thursday, adding, “Whether that ultimately becomes a problem or not, I think time will tell.” He warned that “many of the specifics (of the rescue plans) remain ahead.”
At least three high-level meetings of European leaders are scheduled over the next three weeks. The outcome of those negotiations and Greece’s request for additional time to repay its debts will determine whether the world’s other rich zone continues to subtract from global growth as a European recession deepens.
Europe is China’s largest export market, and the most recent data coming out of China shows that the Asian powerhouse is feeling the pinch. Economists for months have predicted a soft landing for China’s economy, because its government has engaged in numerous efforts to stimulate domestic consumption to make up for falling exports. But the recent economic data, much of which has fallen to 2009 levels, suggests that it remains an uphill battle.
“China’s transition from export-led growth to domestic-led growth might not be easy and could be disrupted by major social unrest. This is a very big concern,” Ed Yardeni, a veteran financial analyst, said in a research note Friday that cited clients abroad who worry about China’s transition. “However, the sudden slowdown in China’s exports – mostly attributable to the recession in Europe – is forcing China’s leaders to scramble to boost domestic growth. Their immediate reaction over the past two years has been to raise minimum wages. That’s crushing profit margins, which tend to be razor thin even when all is going well. So now companies are scaling back their hiring.”
China adds uncertainty on top of European and American uncertainty. It all helps explain why the Fed’s Open Market Committee moved aggressively Thursday, shrugging off criticism from politicians and pundits alike.
“I think the committee feels that nobody else is doing anything . . . and they have to be the only ones who are playing in the game,” said Dean Croushore, a former vice president of the Federal Reserve Bank of Philadelphia who’s a professor at the University of Richmond in Virginia.