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US economy perks up, but risks abound

Steve Helber / AP

Welders spot-weld parts on a door frame at the Volvo truck assembly line at the Volvo plant in Dublin, Va. Factory output is up and that's one of the signs the economy 's pace may be ... slowly ... accelerating.

There were compelling signs this week that the U.S. economy is, ever so gradually, picking up speed. Keeping the recovery on track, though, will mean dodging several very large obstacles that could derail it again.  

The latest piece of upbeat news came from the Conference Board, which said Friday that its index of leading economic indicators jumped by 0.9 percent in October, up sharply from a 0.1 percent increase in September and a 0.3 percent rise in August. 

The private research group said much of the increase was due to a rise in building permits for future construction, which jumped nearly 11 percent in October, to the highest level since March 2010.

The dismal housing market has been one of the main dampers on the U.S. economic recovery. Now, four years after the new housing market all but shut down, home construction is showing signs of life. On Thursday, the Commerce Department reported that single family housing starts jumped 3.9 percent in October. A separate report by an industry group found that homebuilders are getting more optimistic than they've been since May 2010.

"I think everyone is feeling a little more confident in what they think future looks like," said Frank Sorrentino, CEO of North Jersey Community Bank, which lends to home builders in Northern New Jersey. "I don't think anyone believes were falling off a cliff any more, and people are starting to think that 2012 may actually start to look like a decent year."

Other recent economic data -- on everything from jobs to retail sales -- are pointing to an improved outlook for next year. New claims for unemployment insurance, which tend to track the pace of layoffs, fell to 388,000 in the latest week, a seven-month low. It was also the fourth decline in five weeks. That's a sign that the job market has at least stabilized.  

U.S. manufacturing forged ahead last month. The Federal Reserve said Wednesday that industrial output rebounded in October by 0.7 percent after slipping a bit in September. The report also showed that capacity utilization, which measures how much of the manufacturing base is being used to make goods, jumped to 77.8 percent, the highest level since July 2008. A separate report from the Institute of Supply Management, a trade group, showed that output is expanding for both services and manufacturing.

Consumers are also doing their part to get the economy moving again. Retail sales rose by a half-percent last month, the fifth consecutive increase. Retailers report that relatively strong back-to-school shopping results bode well for the upcoming holiday season. Consumers are also catching a bit of a break as inflation appears to have flattened. The consumer price index fell by 0.1 percent in October, largely because of a 3.1 percent drop in gasoline prices.

No one could be happier about the string of upbeat data than the Federal Reserve. After recently cutting their growth forecasts for the fourth quarter of this year and for 2012, the Fed's policy makers have been on the sidelines, holding their breath and waiting for signs of improvement. So the recent data pointing to revived growth and low inflation give the central bankers some welcome breathing room.  

"I think the news has surprised on the upside for the last six or eight weeks here," said St. Louis Federal Reserve President James Bullard. "That's very helpful to us." 

The U.S. economy is hardly out of the woods, though. Unemployment remains stuck above 9 percent. The job market needs to grow at least twice as fast as its current pace to begin to make a dent in that number. For those workers who still collect a paycheck, wages have been stagnant. That means much of the recent uptick in spending is coming from their savings, not from earnings.  

A recent rise in oil prices, if it pushes gasoline prices higher again, could also squeeze consumers' budgets.  

Despite signs of life in new home construction, the overall housing market remains mired in the fourth year of a deep recession. House prices have recently begun to fall again, after stabilizing this summer. Falling home prices hurt the broader economy in two ways. First, they cut further into the household wealth of those who still have equity. Price declines also push more homeowners further underwater, owning more than their house is worth.

Home prices will remain depressed as long as the pace of foreclosures remains high and bankers move those seized properties on the market at distressed prices to sell them quickly. The latest data on foreclosures indicate that it will be several years, at least, before the pace of new foreclosures falls to anything like "normal" levels.

The U.S. economic recovery could also be derailed by the growing financial crisis in Europe, which threatens to swamp eurozone banks with heavy losses if Greece or Italy default on their massive debts. The crisis has already tipped Europe toward a recession, which would hurt demand for U.S. exports to the world's largest markets for American-made products and services.

Closer to home, the congressional supercommittee tasked with forging a budget compromise is just five days away from a deadline to reach an agreement. Two of the most contentious spending programs in the highly politicized debate, which expire at the end of the year unless renewed, have given the recovery an important boost this year.  

A temporary payroll tax cut has put roughly $1,000 to $2000 per household back into consumer spending this year. And federally-supported extended unemployment benefits have paid another $300 a week for up to 99 weeks. Economists generally estimate that those two spending programs combined account for roughly 1 percent of gross domestic product.

"It would be very difficult for an economy that's doing well to digest, let alone one that's barely growing at potential," said Ryan Sweet, an economist at Moody's. "That could unwind a lot of the improvement we've seen so far."

The supercommittee is also considering changes in the tax code. Businesses are already uncertain about the future of favorable provisions in the existing rules. That may have prompted some companies to accelerate spending in second half of this year, according to Jim LeCamp, an investment manager with RBC Wealth Management.

"We've had a lot of business spending that has occurred because this fiscal drag is coming," he said. "We have expense schedules, depreciation schedules, all set to expire at the end of this year."

That could mean business investment, one of the main drivers of the recovery, will slow again in the first half of next year.

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