By Patrick Sims, (202) 822-1205, psims@hamiltonps.com

2013 will arrive; hopefully our economy does too.

Coming off a winter full of good economic news, the market was willing to look past a host of risks. As employment gains continue to lag and other economic indicators do more to muddy our perception of the economy, the market will turn its focus to the uncertainty surrounding upcoming events.

Even as these external risks present political challenges for the President, the unemployment rate will likely fall below or somewhere around 8 percent as we move into the latter-half of 2012. If participation rate stays at 63.8 percent, the President only needs 176,000 jobs per month to get below 8 percent.

Despite its continued progress, here are a few of the upcoming risk factors:

  • Recession in Europe – Restructuring of debt and newly imposed austerity measures are acting counterproductive to their stated goal, killing prospects for growth. With further downgrades of sovereign debt, the rest of 2012 will be a roller-coaster ride for EU member countries and the Euro. In its recent policy statement, The FOMC said that Europe “continue[s] to pose significant downside risks to the [U.S.] economic outlook.”
  • Housing Correction – On housing and rents, a May 1 article by The Economist was simply titled, “This is how we succeed or fail.” The article highlighted how demand for rental units was at a 15 year high. Further, a report by top-banking and university economists cited that foreclosures could push another 7.5 million families out of their home, flooding the market with renters. This event could trigger more government intervention, dampening the market correction. The increased demand could also drive higher rents, thus higher inflation, something the Federal Reserve has been averse to.
  • Inflation & Unemployment – The Federal Reserve has a dual mandate for price stability and full employment; a challenging balancing act, and what some consider to be one of the most difficult jobs ever created. In a recent meeting, Fed Chairman Ben Bernanke and the FOMC expressed that further quantitative easing is less likely, but not off the table. GDP growth forecasts for 2012 were raised, as were projections for inflation. In addition, unemployment projections were lowered, but remained above the Fed’s estimate for the natural rate.
  • Massive Fiscal Cliff – Better known as ‘Taxmageddon’, the scheduled expirations of tax cuts and new tax increases at the end of the year, if not dealt with, will have a negative effect on economic growth. This will have to be faced by a congress that was principally the cause of the debt-limit gridlock leading to the first ever S&P credit rating downgrade in U.S. history. Although it’s unlikely Congress will allow this to happen, if history is any measure, it will come down to the wire. It’s estimated that the taxation could cost the economy $500 billion, or some 3.8 percent of GDP. While growing around a rate of 2 percent, it’s not complicated to see the disastrous result this would have.
  • Health Care Reform – Implementation of Obamacare will come early in 2013. Judicial as well as political concerns have aired recently over the law’s constitutionality; bringing a darker cloud over its fate. U.S. healthcare spending as a percent of GDP is estimated to be the highest of any country at over 15 percent. Uncertainty around such a large portion of the economy is hazardous.

As we approach the election, voters will turn their focus to the highlighted risks. Economists out of Stanford and the University of Chicago recently released a paper examining the correlation between policy uncertainty and slower economic growth. The study found that as a result of increased uncertainty, firms tend to delay hiring and investment, see higher financing costs and exhibit risk-aversion. They concluded that “policy-related uncertainty played a role in the slow growth and fitful recovery of recent years.”

Patrick Sims is a Senior Policy Analyst at Hamilton Place Strategies. Prior to joining HPS, Patrick acted as the lead research analyst in the financial institutions’ group at SNL Financial and worked for the CFA Institute. He is a finance and international business graduate of James Madison University and studied EU Policy at the University of Salamanca, Spain.