Economic Commentaries

18

It is that time of year when we sketch a road map for the year ahead. Looking back at earlier road maps, we dubbed 2010 as the Year of the Fed, arguing that the Central Bank would have to remain extremely accommodative in order to promote economic recovery. We dubbed 2011 as the Year of Government as we thought there would be a focus on debt, deficits, and the unsustainability of the U.S. fiscal condition. We did not foresee the full effect of the Gulf oil spill in 2010 nor the full intensity of the Euro Sovereign crisis, the Arab spring, or the devastating natural disaster that afflicted Japan in 2011.

We are certain to miss aspects of 2012 as well, but with much humility we are characterizing it as a Year of Paralysis. We can not imagine how the U.S. and the global economy will be able to function efficiently given the onslaught of potentially monumental economic policy changes on the horizon. As it is, we do not believe the current fundamentals of the U.S. economy are very positive despite a strong second half 2011 showing.

Fiscal drag at the federal and state level is still in place and will remain so even with payroll tax and jobless benefit extensions. Export markets will feel the effect of weakness abroad. Consumers over spent in late 2011 and they will seek to rebuild saving in 2012. Business pre- spent on equipment to take advantage of expiring tax breaks, so a pull back in investment is in order. To us these headwinds suggest that growth will slow substantially in the year's first half and worries over recession will again emerge. We continue to place the odds of recession in the U.S. at 50%.

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