Hazards Ahead for the Economy

For at least the next six months, the economic outlook isn’t just weak, it’s precarious. Growth of just 2% or so both this year and next isn’t enough to withstand any significant bumps, and the landscape is dotted with hazards that could push the tepid economy into recession. They certainly will dampen consumer spending, as well as business investment and job creation.

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Here's what we see on the horizon:

-- The debt ceiling crisis pushed off till 2013. Although federal borrowing will hit the legal cap long before the end of this year, the Treasury Department will be able to finesse an extension, juggling funds and delaying the day of reckoning till January or February. But that won’t reassure financial markets, which will become increasingly antsy with each day that passes once the official debt limit is breached.

-- Fading odds of a one-year tax deal before January. Polls indicating that a solid majority of Americans favor higher taxes for the country’s wealthiest are bolstering President Obama’s determination to keep rate cuts for all but the highest-incomers.

Plus, with raising the debt ceiling being off the table in a lame-duck session of Congress, there will be less incentive for Obama -- who won’t face voters again, whether he’s back as a second-termer in January or not -- to compromise before the current Congress adjourns, probably in late December. And both parties will figure that waiting till 2013 to deal with taxes and budget ups the odds of cutting a more favorable deal.

-- Eventually, an extension of 2012 rates -- retroactively, if necessary, but maybe not for all taxpayers at all income levels. Ditto for estate taxes: There’ll be a continuation of current rules -- an exemption in the neighborhood of $5 million and a top tax rate of 35%. With corporate rates, capital gains and dividend treatment also up in the air, businesses will put off investment as well as hiring decisions, thus thwarting growth.

-- A last-minute postponement of deep budget cuts now slated to start in January. The unfortunate message to global markets: “U.S. reneges on promise to pare debt.” Worse, there's little reason to expect better follow-through come the next deadline.

-- Rising Mideast tensions and a growing chance of a military strike in Iran. Indeed, it’s less a question of whether Iran’s nuclear facilities will be hit than when and by whom. The U.S. is nowhere near ready to make such a move yet, but Israel can and will act independently if the U.S. won’t, potentially as soon as next spring.

Any resulting oil price spike would be short-lived. But if it comes in the midst of other stresses -- a stalemate over the debt ceiling, for example -- the impact will be multiplied. Just prolonging the worry about a possible supply disruption will sting, holding prices for crude oil and gasoline at artificially high, fear-inflated levels. As Mark Zandi, chief economist with Moody's Analytics, says, “Higher oil prices are always a significant worry. Nothing hurts our economy more.” Meanwhile, China’s growth is slowing and Europe’s woes remain unsettled.

We still expect the U.S. to escape the worst, avoiding another recession. But with pitfalls ahead and on all sides, it's sure to be a bumpy ride.