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Market Perspectives - July 2012

2012 mid-year outlook: Looking past the cliff

The bottom line

At the beginning of the year, we forecast that the economy would experience a soft patch during the second and third quarters due to the situation in Greece and tax problems in the U.S. GDP growth for the year could come in at 2.5%, but that depends on the tax provisions being extended into the next year and no further blow-ups from Europe. Unemployment is likely to stay elevated, with little material improvement in the unemployment rate. There is little reason for businesses to accelerate the pace of hiring if they don't know demand is going to be there for their goods and services in the next year.

Inflation remains subdued, and with unit labor costs and consumer credit (excluding student loans) growing slowly, there are few inflationary pressures. Instead of inflation, we seem to be getting more price distortions and price volatility, with gasoline prices fluctuating and health care costs rising but owner-equivalent rents falling. Low inflation gives the Fed room to give more monetary stimulus to the economy, but that doesn't mean the Fed should do more. It's not as though interest rates aren't low enough or that banks don't have enough reserves on their balance sheets. What matters most to the economy right now are real variables, like jobs, and the Fed can't do much to create jobs right now. More monetary easing might just drive commodity prices higher or Treasury borrowing costs lower. It could provide a bit of support to financial markets, but it's a false support, since the excitement of new easing quickly fades and you're still left with slow growth.

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