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U.S. economy downshifting but not stalled

WASHINGTON (MarketWatch) -- Call it the 2% (or less) economy: The U.S. is still expanding, but at a lukewarm pace that's unlikely to heat up before the end of the year.

The causes of slack growth after a burst of winter activity are well known by now. American consumers cut spending in the spring -- particularly after gas prices spiked -- while export markets for U.S. goods softened. Businesses responded by scaling back hiring plans and putting off major investments, worried about another false start in the nation's effort to break out of its economic straitjacket. See charts on growth, productivity and employment.

That result is a holding pattern in which U.S. unemployment remains high, consumers stay on edge and companies are uncertain about how to proceed.

"You've got more forces pulling growth down than pushing it up," said Steve Blitz, chief economist at ITG Investment Research in New York. "We've downshifted from second gear back to first."

The near-term outlook doesn't seem any brighter.

The looming threat of higher U.S. taxes and deep federal spending cuts kicking in on Jan. 1, 2013 is one potential headache for businesses. Most economists who take part in the regular Blue Chip survey say the so-called fiscal cliff will act as a drag on growth in the remaining months of 2012. Read about Blue Chip survey.

What's more, much of Europe has re-entered recession because of the ongoing financial crisis, and economies all around the world have lost momentum. With demand growing slowly at home, U.S. companies can no longer count on overseas markets to boost sales and profits like they have over the past few years.

"What is different is what's going on in China, India and South America," said Brian Kropp, a managing director at the Corporate Executive Board, an Arlington, Va.-based consulting firm. "The opportunities are not as attractive as they were a few years ago. Executives don't see any markets that seem very compelling."

The sudden caution is evident in the CEB's latest quarterly business barometer survey of senior executives. Less than half now expect to raise production levels over the next 12 months, down from 66% in the second-quarter report.

In addition, more companies (35%) expect to reduce the size of their workforce over the next year than to increase their staff (32%). That's a marked turnabout from earlier in the year.

"Corporate America remains hesitant to aggressively hire or invest against a backdrop of a lackluster economy and significant uncertainty surrounding future fiscal policy," said Jim Baird, chief investment strategist at Plante Moran Financial Advisors.

The anxiety among business leaders is felt by consumers, too. They reduced spending in the late spring and early summer and are saving more money. The drop in consumer spending is a big deal since it drives about 70% of U.S. economic activity.

The U.S. retail spending report for July is not expected to show a dramatic change in consumer patterns. The report, released Tuesday, is expected to post a 0.2% increase in retail spending after a 0.5% drop in June.

A pair of indexes that gauge the health of manufacturing, meanwhile, probably will show an industry that's neither hot nor cold. The Empire State and Philadelphia Federal Reserve surveys are expected to remain at levels suggesting slight or no growth.

The housing industry, for its part, has clearly been on the upswing, but the market is sensitive to broader economic trends, and sales on a historical basis are still extremely low. In July, builders probably began work on new homes at a slightly faster rate than in the prior month.

Add it all up and you have a middling outlook.

"The economy at 2% growth is like a .500 baseball team," Blitz said.