Monday, July 2, 2012

Why world economy is still at risk?

Three years into recovery, Americans have dug themselves out from under mountains of debt and the steep decline in house prices is over. These were supposed to be two secret ingredients needed to spice up a lackluster pace of economic growth.

It's not quite working out that way.

American consumers, who account for the bulk of U.S. economic activity, might be in stronger shape today and are getting an extra boost from gasoline prices, which have tumbled 13 percent over the past three months. That's enough to pump about $120 billion of extra spending power into their pockets over a year.

But uncertainty still looms large and is weighing on growth.

Europe lessened the risks of a euro-zone break-up by striking a deal o n Friday to cut borrowing costs for Italy and Spain and strengthen its banking system. The deal probably clears the path for the European Central Bank at its Thursday meeting to lower interest rates to a record low of 0.75 percent from 1 percent, which analysts widely forecast.

But after 20 crisis summits and endless bickering in Europe, skepticism runs high that the euro-zone crisis is on the way to resolution. And an ECB rate cut would be too little too late to avert a recession in the world's second-largest economic region.

In the United States, action on budget cuts and taxes has stalled until after the November election. This casts a long shadow over business planning and contributes to corporate America slowing its hiring and shelving investment plans.

Against this backdrop, the deleveraging of the overstretched U.S. consumer is not yet providing the hoped-for economic lift. Personal consumption was nearly flat from March through May.

"In a vacuum it would be good news. But we cannot say 'Mission Accomplished' until we know whether the consumer is ready to spend again. And given the uncertain jobs outlook, that is unlikely," said Dana Saporta, U.S. economist at Credit Suisse.


Monthly U.S. household debt payments, which include mortgages, credit cards and car loans, have dipped to 16.06 percent of after-tax personal income, back to the average level seen during the 1990s and down from a peak of 19 percent in late 2007 when the financial crisis began.

The total household debt burden also has fallen, to 106 percent of income from a peak of 125 percent five years ago. It now has reached its lowest level since late 2003 at the start of the housing boom.

But total debt remains above its peak in prior recessions, and economic studies have reached no consensus over what would constitute a "healthy" level for personal debt since it depends on the outlook for growth in asset values and personal income gains.

In other words, borrowing can be a good investment as long as the household can keep up with the debt payments. With a weak jobs market and flat to falling incomes, that's more difficult.

The data are even harder to interpret, said Jacob Oubinas, a U.S. economist at RBC Capital Markets, because they give no insight into whether the debt ratios are improving because people have defaulted, as opposed to refinanced, and whether their incomes have fallen, which limits their spending capacity.

So household deleveraging may be happening, but not in a way that supports much economic growth in the short term.

Even signs that the housing market is stabilizing could be misleading. S&P/Case Shiller reported that single-family home prices rose for the third month in a row in April. But prices are down 1.9 percent year over year, and a bottoming may encourage banks to put more foreclosed properties onto the market, which could further depress prices.

"There are some positives out there, but much of it will depend on the labor market. That is the most important driver of all," said Jim O'Sullivan, who takes over as chief U.S. economist at High Frequency Economics later this month.


The news on the labor front is not very encouraging either.

The Conference Board's survey of consumers found that jobs grew harder to get in June and its gauge of the jobs outlook six months hence was at its weakest level since the turn of the year.

A separate survey of small businesses in May by the National Federation of Independent Businesses provided a more mixed picture. Employers reported that they planned to increase hiring slightly in coming months and that job vacancies were up, but their overall business confidence was flat and most business owners expected conditions to worsen over the next six months.

RBC Capital said that when business expectations are deteriorating, it usually means that hiring stalls.

Big corporations also face weakened conditions. Analysts surveyed by Thomson Reuters have trimmed their forecasts for second-quarter profits among Standard & Poor's 500 companies to a 6.3 percent rise from the 9.2 percent forecast in April.

"The risk is that the U.S. corporate sector is turning more cautious in the face of domestic uncertainty and global weakness. The recent slowdown in hiring points in this direction," JPMorgan said in a note to clients.

Accordingly, the U.S. employment June jobs report on Friday is expected to show sluggish growth, with 90,000 new positions added outside the farm sector, according to a Reuters survey. While this would be a slight improvement from the 69,000 added in May, it is roughly half the number required to make a significant dent in the 8.2 percent unemployment rate.

"Given Europe and the U.S. fiscal fight, it is not an environment that is ripe for hiring," said Oubinas.