How Much Will The Economy Slow?

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Amidst all the great earnings reports coming from U.S. companies this week there is disquieting talk of a real slowdown ahead in the economy. I was reminded of it Tuesday morning when PIMCO’s Mohamed El-Erian stated on Bloomberg TV that the indicators his firm watches most closely (and presumably trusts the most) show that “the economy continues to lose momentum.” Also, mutual fund giant Vanguard released its economic forecast Tuesday in which it noted that “Near-term risks remain tilted toward the downside owing to important headwinds involving real estate, consumer balance-sheet repair, and, most recently, the sharp transition toward fiscal austerity in Europe.” Vanguard’s analysts put the probability of a double-dip recession at 20%. That may sound optimistic but it’s unusual, they note, to even be considering recession’s possible return  so early in an economic recovery. Also, there’s a lot of room for slowdown before you trip the double-dip switch.

So how big a slowdown is coming? Part of the answer depends on what, if anything, the feds do on the stimulus front. There could be some backstage action, such as the Federal Reserve buying securities, but there’s not much ammo left on interest-rate cuts. The folks at High Frequency Economics see a gentle GDP slowdown from roughly a 2.5% rate in the second quarter to a 2% rate over the final two quarters of the year. To their eyes, the stock market is stable, consumer confidence is holding and capital spending is rebounding. The economists at Goldman Sachs are expecting a 1.5% rate over the second half, hardly something to get excited about. As Goldman economist Jan Hatzius notes, “Absent  substantial further stimulus, we worry that final demand will recover only very slowly given the continuing headwinds on sectors such as housing, consumption and state and local spending.” I, for one,  see a big potential problem for the stock market if earnings estimates have to readjust to that 1.5% number.

The second quarter advance GDP estimate won’t be released until Friday, July 30th, and it will surely undergo revisions. But it promises to be an interesting day no matter what the report says.

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