The man with his finger on the pulse says the U.S. economy faces two main risks

July
24

Written by: Jon McGraw

The man with his finger on the pulse says the U.S. economy faces two main risks. We have no control over one of those risks and the other, well, we do have some control, but whether our politicians will appropriately exercise that control is a big question.

Federal Reserve Chairman Ben Bernanke faced Congress last week and he delivered a rather subdued outlook in his semi-annual monetary policy report. He said our economy faces two major headwinds:

  • The Euro-area fiscal and banking crisis and its potential spillover effects on our economy.
  • The unsustainable path of the U.S. fiscal situation (e.g., the “fiscal cliff”).
  • Source: Federal Reserve

The U.S. has little control over the euro-area situation so we’re at the mercy of European leaders to make bold and tough decisions to get their houses in order. The second item, though, is clearly within our control.

The so-called fiscal cliff, in which a series of tax hikes and spending cuts will take effect in 2013 if Congress takes no further action, could throw the economy back into a recession. The Congressional Budget Office estimates if no policy changes are made, then our 2013 federal budget deficit will decline by about $600 billion. On the surface, that sounds great. However, such a huge shock to our system in a short period of time could be problematic.

So, will Congress agree to adjust the legislation for the benefit of the economy? We’ll see.

For his part, Bernanke said the Federal Reserve “is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.” It’s good to know that the Fed is ready to help if needed.

 


Data as of 7/20/12

1-Week

Y-T-D

1-Year

3-Year

5-Year

10-Year

Standard & Poor’s 500 (Domestic Stocks)

0.4%

8.4%

2.8%

12.7%

-2.3%

5.2%

DJ Global ex US (Foreign Stocks)

0.6

0.5

-16.9

3.3

-7.8

5.6

10-year Treasury Note (Yield Only)

1.5

N/A

2.9

3.6

5.0

4.6

Gold (per ounce)

-1.2

0.1

-0.6

18.3

18.3

17.2

DJ-UBS Commodity Index

4.2

3.9

-11.1

6.3

-3.4

3.8

DJ Equity All REIT TR Index

-1.1

16.0

9.5

31.4

2.7

12.1

 

IT’S BEEN ALMOST A YEAR since August 5, 2011, the day the U.S. lost its coveted AAA credit rating from Standard and Poor’s. So, how have the financial markets responded in the year since? Quite well, actually.

It may not feel like it, but the broad U.S. stock market, as measured by the S&P 500 index, rose 13.6 percent between August 5, 2011 and last Friday, according to data from Yahoo! Finance. Despite all the angst from the credit downgrade, the threat of a double-dip recession and the turmoil in Europe, the stock market has hung in there.

The returns in the bond market are perhaps even more startling. The 10-year Treasury yielded 2.56 percent on August 5, 2011 and by last Friday, the yield had dropped to 1.46 percent, according to Yahoo! Finance. Normally, you might expect interest rates to rise after a credit downgrade since the ratings agency is essentially saying your bonds are riskier than previously thought.

The U.S., though, is perhaps a “special” case. The day after the credit downgrade, none other than Warren Buffett went on Bloomberg television and said he thought the U.S. should be a “quadruple A” rating. And, to this day, the U.S. dollar remains the world’s leading reserve currency as more than 60 percent of the world’s foreign currency reserves are held in U.S. dollars, according to BusinessWeek.

We shouldn’t get overconfident, though. While the U.S. has tremendous assets, it might only take a few bad decisions from our leaders to undo what took decades to build.

Weekly Fun – Think About It…

“There is nothing wrong with America that the faith, love of freedom, intelligence, and energy of her citizens cannot cure.” —Dwight D. Eisenhower, 34th president of the United States