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It is hard to examine the economic outlook for the next few months and not be concerned. The sequestration and tax hikes are taking a large bite out of the economy. Meanwhile, analysis of the April employment reports from both the BLS and ADP shows that the Affordable Care Act is likely having a sizable negative impact on payroll and wage growth. Throw in a natural pullback in consumer spending following an outsized gain in the first quarter and the numbers do not add up to growth levels that are anywhere near potential.

Our concerns now focus on the second half of 2013. Many economists are calling for the weakness from the austerity to lift in the second half of 2013. Backed by a continued surge in construction and favorable statistical consumption comparisons, these economists expect growth to reach at least 2.5% and likely exceed 3.0%.

Yet, even though these predictions are still considerably softer than what has happened following previous recessions, there is no guarantee that construction and consumption are stable and secure enough to bring the economy out of its doldrums. For example, new home prices are currently well above normal premium levels compared to an existing home and leave the possibility that price-conscious buyers will reject the additional costs. Furthermore, a deep drop in the savings rate in the first quarter may not be sustainable and force consumers to lay off spending and increase their savings.

With the effectiveness of further monetary policy questionable at best and fiscal policy firmly attuned to deficit reduction, it is difficult to see where secure economic growth can be derived from. Thus, predictions that things will get better are seemingly based on the idea that things have to get better at some time and not based on data-driven analysis.

A data-driven analysis of the economic trends clearly shows cloudy economic conditions with a high chance of a prolonged period of showers. The idea that the sun may finally be breaking through is difficult to discern from today's satellite picture.

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Here We Go Again

In every quarterly outlook for the past few years we have pointed out that there is substantial evidence that the current economic malaise can be alleviated. Specifically, the debt and balance sheet problems that were the main culprit for causing the Great Recession are much more benign today. In fact, it is arguable that the balance sheets for both businesses and households support further debt accumulation and economic growth.

Businesses are saving substantially more than their normal historical levels and those savings are more-than-ever being used to hold liquid assets that receive almost no return.

Meanwhile, household debt-to-income ratios have fallen dramatically from their peak in late 2009 and the debt-to-asset ratio has returned to its long-term trend. All that is left for businesses and households to break out of their current funk is the release of some type of animal spirits. It seems like every quarter economists, including us, believe that the release will happen soon and spark a flood of economic activities.

Yet, the truth of the matter is that the negative effects from the Great Recession remain strongly embedded in business and consumer behavior. Even though the data show that it would be in the best interest for businesses and consumers to return to their pre-recessionary habits, no one is willing to step up and be the leader. Thus, the economy may have reached a stagnation point where businesses are content with their work force and capital stock and consumers are content with their current spending levels.

That would explain why, without surprise, that the initial claims level is at the lowest point since January 2008 while hiring opportunities are shrinking. Under this setup, Keynesians would argue that stimulus measures are the only way to induce demand. With monetary policy butted up against the zero bound, additional fiscal spending is the only way to get the economy moving ahead.

Of course, this is exactly the opposite of what is going on in the U.S. Austerity measures have caused a sizable reduction in overall government spending. The weakness stemming from the austerity can only be offset by an acceleration in the business and/or consumer sectors. However, as we showed earlier, neither one of those sectors is willing to take charge. That means that economic growth remains sluggish even though the underlying indicators suggest that things can improve. Unless animal spirits suddenly appear, there is nothing that can change this prospect.

It is only wishful thinking that the economy will return to potential growth and remain there for a lasting period.

Source: Will The Economic Skies Brighten? Not Likely