washingtonpost.com
Economic recovery threatens to run sideways

By Neil Irwin
Washington Post Staff Writer
Saturday, June 26, 2010; A09

The economic recovery that began a year ago increasingly appears to be on shaky footing, driving financial markets downward and clouding the debate over economic policy.

Just two months ago, a strong, self-sustaining economic expansion seemed to be taking hold, with consumer spending, output of goods and services, corporate hiring and financial markets all on the rise. The latest string of economic data, however, has thrown cold water on that view. On Friday, the Commerce Department revised down its estimate of first-quarter gross domestic product growth to 2.7 percent from the estimated 3 percent.

The components of that revision were particularly worrisome -- not only was growth weaker than thought, but more of it came from businesses rebuilding inventories, which amounts to a one-time boost. Real final sales -- a measure of consumption and investment that can be sustained -- rose at only an 0.8 percent annual rate, hardly the stuff of a roaring expansion.

That followed evidence earlier in the week that home sales are falling rapidly following the end of a homebuyer tax credit. And several regional manufacturing surveys, including those from the Federal Reserve Banks in Richmond, Kansas City, Philadelphia and New York, have shown less optimism around hiring and capital spending among businesses. And the number of new weekly claims for unemployment insurance benefits has remained around January levels, rather than declining steadily as analysts had expected.

"We're not going to keep accelerating," said Alan Levenson, chief economist at T. Rowe Price. "It looks like we're either settling into a cruising speed for growth, or even decelerating."

Economic recoveries rarely move in a straight line, and the recent weakness could well just be a soft patch on the road to stronger growth. Indeed, the economy appears to have continued growing in the second quarter, which ends next week, with forecasters expecting growth at a 3.5 percent annual rate. But many have downgraded their expectations for the second half of the year.

Still, with the unemployment rate at 9.7 percent and a deep recession barely in the rear-view mirror, a slowdown in the expansion -- let alone a dip back into recession -- would further delay the return of 15 million jobless Americans to work.

Because the economy is capable of expanding 2.5 to 3 percent annually in the long run because of population and productivity gains, it takes growth faster than that to meaningfully reduce unemployment.

The softness in the latest economic data appears to reflect uncertainty among businesses prompted by the debt crisis in Europe, a slide in retail sales in May and the fading need to rebuild inventories.

Financial markets are both reflecting the gloomier outlook for the economy -- and feeding it. While the wild swings in the stock market during the height of the European debt crisis have ebbed, there have been steady declines in the prices of stocks and other risky assets over the past week.

The Standard & Poor's 500-stock index fell 3.6 percent for the week, dropping four of five days. The index, a broad-based measure of U.S. markets, was up 0.3 percent Friday. And money has gushed into safe assets, particularly U.S. Treasury bonds, driving down long-term interest rates. The yield on ten-year Treasurys fell to a 13-month low this week, closing Friday at 3.11 percent, down from 3.22 percent a week ago.

The spate of uneven economic data complicates policymakers' decisions. The Federal Reserve this week left its interest rate target near zero and repeated its intention to leave rates very low for an "extended period," while acknowledging new risks to the economy.

But Fed leaders are reluctant to pull out new, more extraordinary measures to support the economy such as buying long-term Treasury bonds. Officials at the central bank hold to their forecast that the economy will grow, if at an unexceptional pace, through the remainder of the year, and it would take a reversal of that basic forecast to consider exceptional measures.

Meanwhile, a bill to extend unemployment insurance benefits and support strapped state governments could not gain enough votes in the Senate to begin debate, bogged down by lawmakers concerned about the budget deficit.

A fiscal pullback by the government creates its own risks for the economy, economists said.

"My sense is the recovery will remain intact," said Mark Zandi, chief economist at Moody's Economy.com. "This won't be enough to push us back into recession. But the odds are uncomfortably high that I'm wrong and that the economy does back track into recession."

Lori Montgomery contributed to this report.

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