Signs We Are Approaching a Zombie Economy

Uncertainty about U.S. fiscal policy, Europe’s sovereign crisis and slower global growth have turned the U.S. economy into what feels like a slow-moving zombie, leaving businesses and consumers hesitant and reluctant to act.

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Those factors combined to hit business confidence and have led to slower activity, evident in Friday’s report showing just 80,000 new jobs created in June. That follows a sluggish 77,000 payrolls in May and 68,000 in April, making the second quarter the worst quarter for jobs in two years.

That report sparked immediate market talk of a new round of asset purchases or “quantitative easing” by the Fed, but the number was not weak enough to generate a clear consensus on when or whether the Fed would act.

CRT Capital Senior Treasury Strategist Ian Lyngen said the economy feels zombie-like. “The risk taking animal spirits have yet to return,” he said.

Europe’s debt crisis and the ongoing drag of deleveraging have made the second leg of the recovery troublesome.

“The U.S. economy has been unable to achieve escape velocity but the amount of monetary and fiscal stimulus in the system has proven adequate enough to keep it going at a 1-2 percent GDP pace. That is slow by historic recovery standards…it feels like a 'zomb'-economy,” said Lyngen.

“People are increasingly worried about a double dip,” he said.

“It feels like it’s sleepwalking,” Moody’s chief economist Mark Zandi said of the economy. "We’re walking but not going anywhere fast. I don’t think we’re dead like a zombie. There is some life underneath, but we are sleepwalking. The reality is people are so nervous and shell shocked, it doesn’t take much to get them to stop what they’re doing.”

Zandi doesn’t think the sluggishness implies a recession. He expects second-quarter growth of 1.8 percent followed by third-quarter growth of 2.2 percent.

“We’re at a 2-percent economy. It doesn’t feel good,” he said. Zandi said one positive is that businesses are basically healthy and while there is a lack of hiring, there is also a lack of firing.

“The only ingredient missing is confidence,” he said. (Related: Unfilled Jobs)

Businesses have held back on spending ahead of the election, because of a lack of clarity on broader policy but also specifically on uncertainty about health care costs, taxes and the “fiscal cliff.” The fiscal cliff is the year-end expiration of tax breaks and a round of budgetary cuts that come in the first quarter if Congress fails to act. The result would be a hit of about 3 percent on GDP next year, but substantially sharper in the first quarter, Zandi said.

“I can’t believe businesses are not out there saying: ‘I don’t have a reason to hire anybody. Interest rates are going nowhere. I can wait a couple of months to see what happens in the election,’” said BTIG chief global strategist Dan Greenhaus. “There is absolutely nothing on their horizon to suggest that between now and the end of the year that anything will change in the economy.”

Even though European leaders are taking actionto stem the sovereign crisis, markets have given them little credit. The faltering economy in Europe is also pinching the U.S. economy, which saw a drop off in manufacturing exportslast month. The recovery in risk assets, like stocks and commodities, that came after last week’s European summithas already faded, and there are again concerns about the Spanish bank bailout haunting the markets. The euro Friday fell to a two-year low.

“It’s like quick sand. It’s like mud,” Greenhaus said of the economic malaise.

Credit Suisse economist Jonathan Basile had another description: “It’s like trying to sprint through molasses. It’s great for conditioning but it’s hard as hell,” he said. Like an athlete, “sometimes when the economy runs too slow, it feels like it hurts.”

Basile expects the Fed to jump in and help out the economy, announcing another round of quantitative easing at its Sept. 13 meeting.

“They tend to do their job, and their job in their eyes is to do what they need to do for the broader economy," he said. "The Bernanke Fed is not one to sit on its hands."

But Zandi does not expect the Fed to take immediate action, as it doesn’t have enough evidence that the economy is heading south.

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“They’re probably a little perplexed by the data. They don’t line up with other numbers,” he said, pointing to the decline in retail jobs.

Zandi expects the Fed to hold back, saving its fire power for the potential of bigger problems down the road.

Greenhaus said it’s likely the Fed acts in September, and there’s not enough reason to do it sooner. But he says in another couple of months, if the economy continues to act sluggishly, the Fed will be at turning point.

“You get to the point where the pressure becomes too much and they’re going to have to do something more than Operation Twist,” said Greenhaus. Operation Twist is a bond purchase program, under which the Fed purchases longer duration Treasurys and sells a similar amount of shorter duration securities, without ballooning its balance sheet as it does in QE.

“They should have two choices. Either do more, or come right out and say monetary policy is not the tool to solve what ails us,” Greenhaus said. “(Fed Chairman) Ben Bernanke is practically pleading with Congress to do something.”

The slower global growth picture is also a factor, and China has been a source of big concern. This week, China surprised markets with a series of rate cuts, ahead of a heavy calendar of economic reports next week. Most closely watched will be second quarter GDP, released Friday morning.

Analysts are watching to see if the second quarter is the trough, and may expect a pickup going into the third quarter. “If China accelerates, it wouldn’t be bad for the whole world,” Greenhaus said.

Greenhaus said the economy is like a store that is waiting for customers. It could hire if it could bring them in the door. “The question is how do you get those people on line. That is the nature of the debate right now. Unfortunately, there is no silver bullet answer—if we did this everything would be fine. You can’t just say reduce interest rates, cut taxes. You can’t just do that because there’s so many other things going on,” he said.

Zandi said he expects things to improve after the election. “I think Europe is going to hold together. I don’t think they’ll let it unravel. I don’t think policy makers are going to take us over the fiscal cliff,” he said.

Zandi said he is also expecting the U.S. consumer to get a boost from lower gasoline prices. For each penny reduction, consumers save $1.25 billion a year over a period of a year. Gasoline prices in the past month have fallen 21 cents nationally, to an average $3.35 per gallon, according to AAA.

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