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Economic Recovery Still Challenged by European Concerns and Energy Prices

Consumers and businesses keep telling us conditions are bad. But the recent economic data have been surprisingly solid, pointing to an accelerating recovery. Unfortunately, the economy has had nothing but bad luck and the problems facing Europe and rising energy costs are two more hurdles that must be cleared before solid growth returns.

The economy is expanding and the pace of economic activity quickened during the summer. Third quarter GDP growth of 2.5% is hardly gangbusters but the details of the report were better than the headline. Consumers are spending again with big-ticket purchases leading the way. But more importantly, services demand has come back. This lagging component is nearly two-thirds of all spending and a turnaround here would be welcome news. With October retail sales being even better than expected, it looks like the holiday shopping season has gotten off to a strong start as well.

What really powered growth, though, was robust business spending. Investment in equipment and software was up double-digits with firms building new plants to house the machinery. Some of the need for construction is coming from foreign demand as exports are improving. The only negative was a draw down in inventories. But businesses probably underestimated demand. As they restock their shelves, activity will expand further over the next few months.

Normally, solid business and household spending would cause the labor market to improve. If you believe the October employment report, that is not yet the case. Payrolls rose by a disappointing 80,000 with the private sector adding 104,000 new workers. As usual, state and local government cutbacks are restraining the gains. But previous months’ data have been revised upward and that usually points to accelerating hiring.

Indeed, when you look at other labor market data, the picture seems a lot better. Critically, unemployment claims are coming down, having reached levels that point to the unemployment rate falling. There was a small decline in the rate in October, to 9.0%, and I wouldn’t be surprised if we see it go below that in November. Nothing is hurting confidence more than the moribund labor market and it appears that conditions are changing. Lots of jobs are not available, but hiring should pick up over the next few months.

Of course any forecast for 2012 has to take account of the two gorillas in the room: European sovereign debt problems and oil price increases. Progress is slowly being made on dealing with the Greek and Italian crises but there are also concerns about Spain, Ireland and Portugal as well. Don’t expect the worries to disappear soon – meaning market volatility will continue. But unless there is a massive default, a major worldwide financial crisis can be avoided. Nevertheless, if Europe sinks into recession our exports will be affected.

And then there is oil. Petroleum broke through $100 a barrel and gasoline prices should rise. How high they will get to is unclear but we know that $4.00 a gallon is a deal breaker for households.

The economy is moving forward but the combination of rising energy costs and European debt difficulties will undoubtedly keep growth from accelerating sharply. While a double-dip recession isn’t likely, we are still a long way from strong growth.

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Posted in Industry News.

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