Economy in U.S. Vulnerable With GDP Short of Pre-Recession Peak

The world’s largest economy has yet to regain the ground it lost during the recession and may be vulnerable to a relapse.

Gross domestic product expanded at a 1.3 percent annual rate in the second quarter, after a 0.4 percent pace in the prior period, the worst six months since the recovery began in June 2009, Commerce Department figures showed yesterday. Economists said the slowdown leaves the recovery susceptible to being knocked off course by shocks at home or abroad.

“We are in a fairly risky situation,” said Nariman Behravesh, chief economist at IHS Inc. in Lexington, Massachusetts, the only firm polled by Bloomberg News to correctly forecast last quarter’s figure. “Growth is weak and there are some possible problems out there: our own fiscal situation, Europe’s debt crisis, and there is always a risk that oil prices could shoot up.”

The slow recovery left GDP at $13.27 trillion in the second quarter, below the $13.33 trillion peak of the fourth quarter of 2007, after a recession that was about 25 percent deeper than previously reported. That puts pressure on Federal Reserve policy makers to explore additional steps to boost the economy, including another round of bond purchases.

“This raises some very difficult issues for the Fed,” said Julia Coronado, chief economist for North America at BNP Paribas in New York. “They will certainly have to put all options on the table and see what they can do. One more shock and we could tip over into recession.”

Debt Ceiling

Congress may deliver that shock. With three days left until the Treasury Department runs out of borrowing authority, Republicans and Democrats are still at odds over what budget cuts they should make before raising the $14.3 trillion debt ceiling.

The squabbling is a “confidence hit” for both U.S. and international businesses and casts a pall over the economy in the second half, said Mohamed El-Erian, chief executive officer of Pacific Investment Management Co.

“We have signaled that we can create a crisis out of thin air,” said El-Erian, whose Newport Beach, California-based Pimco runs the world’s largest bond fund. “This will create a headwind to growth.”

Congressional agreement on budget cuts could cause troubles of its own. Less spending by the Federal government would be “a real problem” for the economy, Guy LeBas, chief fixed income strategist at Janney Montgomery Scott LLC in Philadelphia, said in a July 29 interview on Bloomberg Television.

Recession Risk

“We could see a growing risk of recession in the fourth quarter, early 2012, if in fact the federal government gets it together and makes aggressive budget cuts,” LeBas said.

Economists are lowering forecasts for second-half growth in the wake of the latest GDP numbers and the stalemate in Washington. Behravesh of IHS said growth would at best reach 2 percent this quarter and could come in as low as 1 percent. In early July, he was projecting 3.4 percent.

Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities in New York, reduced his estimate by 1 percentage point to 2.5 percent for the third quarter, and trimmed it to 3 percent from 4.3 percent for the final three months of 2011.

Dean Maki, chief U.S. economist at Barclays Capital in New York, cut his projections by a full percentage point for this quarter and the following five. He expects GDP to grow 2 percent from July through September and 2.5 percent in the fourth quarter. Maki also wrote in a note that the Fed will keep interest rates near zero through the end of 2012.

Stocks Decline

Treasuries rallied, sending yields on 10-year notes to the lowest level this year, and stocks fell as economic growth trailed forecasts amid speculation lawmakers will reach a compromise to avoid a government default.

The yield on the benchmark 10-year note decreased to 2.79 percent at 4:21 p.m. yesterday in New York from 2.95 percent on July 28. The Standard & Poor’s 500 Index fell 0.7 percent to 1,292.28.

Revisions to GDP figures going back to 2003 showed the 2007-2009 recession took a bigger bite out of the economy than previously estimated and the recovery lost momentum throughout 2010. GDP shrank 5.1 percent from the fourth quarter of 2007 to the second quarter of 2009, compared with the previously reported 4.1 percent drop.

Growth in the first quarter of 2011 was revised down from a 1.9 percent prior estimate, reflecting fewer inventories and more imports, the Commerce Department’s report showed.

Consumers Pull Back

Much of the weakness last quarter came from a pullback in consumer spending, which accounts for about 70 percent of the economy. Household purchases rose 0.1 percent, the smallest gain since the April-June quarter of 2009. The slump reflected a 4.4 percent plunge in purchases of durable goods like automobiles.

Higher expenses for food and energy may have curtailed spending on less essential items. The cost of a gallon of regular gasoline climbed in May to about $4 a gallon, the highest in almost three years, according to AAA, the nation’s biggest auto group.

The absence of faster job growth is also weighing on Americans. The unemployment rate climbed to 9.2 percent in June while payrolls grew by 18,000, the fewest in nine months, Labor Department figures showed on July 8.

Purchase, New York-based PepsiCo Inc., the world’s largest snack-food maker, said profit this year will increase more slowly than it previously projected because of rising commodity costs and cooling customer demand.

“It’s the consumer and competitive picture that has become more difficult than we expected,” Chief Executive Officer Indra Nooyi said on a July 21 conference call.

Employment Outlook

The employment outlook remains dim. Whitehouse Station, New Jersey-based Merck & Co., the second-largest U.S. drugmaker, said yesterday that it plans to cut an additional 12,000 to 13,000 jobs by 2015. Earlier this month, announcements showed Cisco Systems Inc. (CSCO) will trim about 6,500 jobs worldwide; Goldman Sachs Group Inc. may reduce staff by about 1,000, and Lockheed Martin Corp. (LMT) will offer a voluntary separation plan to 6,500 employees.

Other reports yesterday indicated a weaker start to the second half. Business activity cooled in July from the prior month, and consumer sentiment tumbled to the lowest reading since March 2009.

“The risk is that you’ve slowed down to the pace where the economy stalls,” said Michael Carey, chief economist for North America at Credit Agricole CIB in New York. “Frankly, that’s a bit of a scary prospect.”

To contact the reporter on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net Rich Miller in Washington at rmiller28@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz in Washington at cwellisz@bloomberg.net

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