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Tuesday, August 2, 2011

U.S. debt not only crisis on horizon




The United States looks set to escape a crushing debt default, but it has yet to find a way to escape the economic quicksand.

A half-hour into a relief rally on the bi-partisan deal to raise the United States’ borrowing ceiling and cut the deficit by US$2.4-billion, markets were undercut by figures showing manufacturing activity plunged to its slowest pace in two years.

The figures were much worse than forecast and add to a string of data showing the world’s biggest economy virtually grinding to a halt this summer.

Add in the fiscal drag from the debt deal — an initial US$917-billion in cuts across the board covering everything from the military to food inspection, followed by US$1.5-trillion still to be thrashed out — and some economists say the risk of a new recession looms large.

“So we are starting the second half of the year with the so-called economic ‘soft spot’ looking more like a gulley,” Sherry Cooper, chief economist at BMO Capital Markets said. “Additional fiscal tightening in this environment runs the risk of tipping the U.S. economy into another recession.”

The Institute for Supply Management (ISM) said its index of national factory activity fell to 50.9 in July from 55.3 in June. That was the lowest reading for the index, which surveys U.S. purchasing managers, since July 2009, when it registered 49.

A reading of less than 50 indicates contraction in the manufacturing sector, while more than 50 suggests expansion. Economists surveyed by Bloomberg News had been expecting 54.5.

“I think it’s quite worrying really and suggests that the sharp slowdown in economic activity we saw in the first half of the year appears set to continue into the second half, which is generally against what everyone thought,” said Paul Dales, senior U.S. economist with Capital Economics.

Most observers felt the sluggish first half of the year was just a soft patch or temporary slowdown that would soon be reversed, he said. “The more data we get, the more it looks like that’s not necessarily the case and it’s more of a sustained slowdown.”

Although the U.S. economy is still growing — GDP numbers out last Friday showed the economy expanding at a rate of just 1.3% in the second quarter of the year after revisions took a big bite out of previous quarters — growth is much too slow to start generating jobs and become self-sustaining.

As the country looks to rein in its debt, it is likely to move into a period of sustained fiscal austerity that could further hamper growth.

“In an environment where the United States is trying to sort out its fiscal situation, the consequence of that will be a number of years of really weak economic growth,” Mr. Dales said.

Jennifer Lee, senior economist at BMO Capital Markets, said that uncertainty generated by the brinkmanship of U.S. lawmakers likely affected the ISM manufacturing numbers.

“Nobody can make decisions on investment plans or hiring plans if they don’t know how the economy’s going to be faring in the next three to six months,” she said. “Everyone was holding back on what they were planning to do and you’re seeing that show up in the numbers now.”

Tom Porcelli, chief U.S. economist for RBC Capital Markets in New York City, agreed that the uncertainty around the debt ceiling likely influenced the ISM measure to some degree. But he cautioned against attributing the slump entirely to the drama in Washington.

“I don’t think anyone can deny that the general trend in ISM dating back to around February has been one of slowing activity in the manufacturing space,” Mr. Porcelli said.

It’s questionable whether the debt ceiling talks alone could influence the sub-category of new orders into slipping below the break-even level to 49.2%, the first time it has hit that level since June 2009, he noted.

“We have recently scaled back our second-half expectations for growth in the U.S.,” he said, adding that the likelihood of the country slipping back into recession, while still low, has increased.

“It’s certainly not part of our forecast horizon, but I think we have to recognize that the odds have risen.”

Meanwhile, Andrew Busch, global currency and public policy strategist with BMO Capital Markets in Chicago, said the ISM numbers — along with recent soft PMI data in countries like Australia, South Africa and the influential China — point to a possible worldwide slowdown.

“I would say we’re in the slowest growth point of the year for the global economy. If it does not return to faster growth in the third quarter, this is going to be a pretty horrific year,” he said.

“So much of the debt crisis in the U.S. is obfuscating the bigger issues, which are slowdown in global growth and truly the European debt crisis, which is not over yet.”

Financial Post

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