- The Washington Times - Wednesday, June 24, 2009

After a heady period of hope that spurred a nearly 40 percent rise in major stock indexes from March through May, a sober reality has set in. The economy remains mired in recession and likely will experience only a gradual recovery with little or no job growth for months to come.

President Obama acknowledged the darker outlook Tuesday, only a day after the White House predicted that the unemployment rate would rise into the double digits this year. But he said he has no plans for a second bill to provide economic stimulus, with the first one just starting to take effect.

“We’re not at actual recovery yet,” the president said at his news conference, asserting that the recession proved to be worse than most economists expected. “Nobody understood what the depths of this recession were going to look like.”

Major stock indexes already have lost more than 5 percent of their value in recent days as the new reality set in. Mr. Obama noted that foreclosures have soared beyond expectations, swamping programs he established to try to minimize the housing rout.

Millions of jobs have been lost since the beginning of the year, and many more will be lost before it ends. But the job losses in state and local government would have been worse without the stimulus bill, he said.

Beyond the renewed doubts about the economy as unemployment, defaults and bankruptcies continue to rise, a worry is lurking in the markets that the stimulus bill is having only a limited effect and that the federal government may be running out of ammunition to combat the recession.

The federal debt already is at astronomical levels and has recently fed a sharp rise in mortgage rates and other long-term rates - a development that threatens to upset the fragile stability that recently emerged in the housing market and the broader economy. That stability was the slim reed on which many economists were pinning their hopes for a recovery by the end of the year.

Moreover, the run-up in market interest rates has left the Federal Reserve with dwindling options as it strives to bolster the prospects for recovery. With 30-year mortgage rates now close to 5.5 percent, they already have retraced the dramatic reduction to nearly 4.5 percent that the Fed engineered at the beginning of the year with an unprecedented campaign of buying mortgage and Treasury bonds.

Although the Fed is expected to keep short-term interest rates as close to zero as possible at a meeting this week, the Fed is being badgered by a small but vocal group of influential economists who say the central bank should consider raising rates soon to stave off a bout of inflation that could be ignited by the mounting federal debt and the Fed’s easy-money policies.

The letdown as these ugly realities set in has already caused substantial damage in financial markets, with stock indexes losing more than 5 percent of their gains in recent days. Stocks were even unable to rally Tuesday in the face of good news that existing-home sales rose by 2.4 percent last month, bolstering the case that the housing market may be on the verge of recovery after years of decline.

“How can people get so excited when we are still in such a mess?” asked Louise Purtle, analyst with CreditSights, an investor research firm, explaining the new psychology for investors.

Although rays of hope were emerging in housing and manufacturing, and consumer and business sentiment have improved, the strong rally seen in financial markets far outpaced the sporadic evidence of an emerging economic recovery, she said.

“The economy is at best convalescent,” she said, with few signs of strength seen in the economy’s main engines of growth — consumer and business spending. Consumers’ incomes and employment have been shrinking and are not strong enough to sustain the growth in spending needed to end the recession, she said. Meanwhile businesses have little reason to invest with their sales declining.

The market’s improvement since March was justified in part by the stabilization in the banking and financial system during the spring and a revival of interest in higher-yielding investments, she said.

But loan losses at banks continue to mount, she said, which is one of the reasons that the rebound from the recession will not be as strong as that seen in past eras.

Another reason for the sluggish recovery is that the government has become “too much involved” in the economy, she said, partly as a result of its efforts to revive growth. The mushrooming federal debt, which has set off higher interest rates, is one example of how the government’s efforts can backfire.

“We are looking at an economy in which there has been a ratcheting up of government spending and government involvement in many industries,” she said. “With an era of expanding regulation and decreasing private-sector leverage, it makes for an outlook of a dismal upswing that will see continued high unemployment.”

Jeffrey Kleintop, chief market strategist at LPL Financial, said the spring run-up in interest rates and gasoline prices - both of reached a “threshold of concern” around June 11 — forced the markets to reassess the prospects for the economy.

But now interest rates and gas prices have retreated some, in a “self-correcting” process that should renew the prospects for healthy growth, he said.

“Further healing in the economy and the markets is likely as key drivers self-correct and keep the progress on track,” he said.

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