U.S. economic data point to a downshift in momentum beginning in March. Some of the March-June slowdown can be attributed to weather given that unusually mild winter weather coincided with stronger U.S. data from December through February. However, that looks to be only part of the story. The slow-motion train wreck called the Euro-zone remains an unsettling spectacle. Beyond the depressive effect on animal spirits worldwide, we are now seeing a direct drag on U.S. trade because of the spreading recession in Europe. U.S. merchandise exports to the Euro-zone went negative on a year-over-year basis in April, down 4.70 percent. Moreover, the spreading malaise in Europe is eating at their banking system, which is linked to ours. The political situation in Europe is adding a layer of complexity to any possible solutions to the malaise. Governments are turning over and potential new governments may seek to renegotiate existing agreements. Moreover, most potential solutions to the euro-zone crisis involve at least a small loss of sovereignty for the individual nations as they cede more power to the EU as a whole as well as to the European Central Bank. Politics does not have to follow economics as popular opinion trumps long-term fiscal realities. As if the Euro-flu was not enough, we are also seeing cooler growth in Asia. Manufacturing indexes for China point to at least a mild contraction in that sector as export demand cools. Domestic demand still has plenty of room to grow but a sputtering U.S. economy and a downward spiraling Europe is impacting the world’s leading exporter of stuff. China has begun to ease monetary policy in response to weakening demand for its exports. They have the resources and capacity to add aggressive stimulus if needed, and so the expectation for China remains a soft landing instead of a crash. India is also cooling and Japan is vulnerable to a post-rebuild slump. Then we come to the “Fiscal Cliff,” which is going to knock the U.S. economy back into recession in early 2013 if nothing is done to smooth it out, according to the Congressional Budget Office. The combination of large tax increases and major spending cuts could hardly be coming at a worse time given the situations in Europe and Asia. All told, a dark and scary stage is set for next week’s meeting of the Federal Open Market Committee. The FOMC has the opportunity to launch new monetary stimulus coordinated with Chinese monetary easing, expected European Central Bank easing, and Bank of England monetary easing. QE3, if launched next week, may be a short-term lifeline for the U.S. economy, but it must be followed by Congressional action on the Fiscal Cliff to clear the way for U.S. economic growth in 2013.
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