The Federal Reserve's efforts to jump start the struggling U.S. economy dominated the quarter's headlines. In early August, the Fed announced it would hold short-term interest rates near 0% until at least mid-2013. The Fed's move accompanied a downbeat forecast in which it noted a depressed housing sector and deteriorating jobs market. The Fed acted again in September when it announced plans to sell $400 billion in short-term Treasury bonds in its portfolio by June 2012 and buy longer-term debt, a move aimed at further driving down long-term borrowing costs. The Fed also said it would maintain its investments in mortgage-backed debt at current levels, instead of paring its mortgage holdings as it has done over the past year, in an attempt to boost the ailing housing market. On a more negative note, the central bank noted "significant downside risks to the economic outlook, including strains in global financial markets."
At the end of August, the Commerce Department reported the U.S. economy grew at a 1.3% pace in the second quarter of 2011. However, other indicators continue to point to a sluggish economy. Job creation stalled in August, when the unemployment rate was stuck at 9.1% for the second straight month. Consumer confidence fell to multi year lows, as consumer worries about the weak jobs market and falling stock prices escalated.
Investor uncertainty has increased markedly in recent weeks, but we see reasons to be cautiously optimistic. We believe odds of an outright recession are around 50%, despite growing talk that the U.S. is sliding into another downturn; although the ECRI has officially called for a US recession in 2012. A more probable scenario is a "stealth growth recession" characterized by extremely low economic growth and high unemployment.
The situation in Europe remains a bit troublesome, as economic growth is slowing across the Eurozone, loan losses continue to pile up, and the risks of a banking crisis are growing. A Greek default looks increasingly likely; it seems to be just a matter of when. However, European policymakers appear to have finally grasped the gravity of the crisis, and we believe the odds are favorable that they will take sufficient action to prevent it from spreading.
While the news over the past several weeks has been fairly negative, the one thing missing from the constant cascade of worrying headlines is any hint of deterioration in US corporate earnings, at least at this point. Earnings estimates will need to be watched carefully in the coming weeks/months for signs of a slowdown. So far this month most earnings reports have come in better than expectations, which is a good sign for continued profitability by corporations. S&P 500 earnings estimates for 2011 are still hovering around $98.00 (up slightly from the first quarter); with continued expectations for roughly $108.00 in 2012.
