London, 19 July 2011: Reuters

The U.S. economy is struggling to escape from the soft patch that began in April. With no sign of sustained momentum, forecasters and investors may soon need to mark down predictions for consumption and commodity prices in the second half of the year.

The Institute of Supply Management (ISM)'s manufacturing survey registered a small bounce in June (55.3) from May's sluggish reading (53.5) and remains above the 50-point threshold dividing expanding activity from contraction.

Clinging to the argument that this is just a transitory problem, senior Federal Reserve officials point to stabilising commodity prices and strong summer production schedules at U.S. automakers as reasons to expect an improvement in the next two to three months. That would ease pressure on households and provide a fillip for industrial demand.

But other indicators paint a darker picture. The recovery has lost momentum at a surprisingly early stage in the cyclical upswing and is struggling to find self-sustaining sources of growth.

In fact, the current picture looks a lot like the summers of 2003 and 2010. On both occasions, the Fed eased policy to reinvigorate the economy, citing fears about deflation, though the policy also helped re-accelerate growth.

This time around, however, the economy is struggling under the impact of rising food and fuel prices, and is already supported by strongly negative real interest rates, limiting the Fed's room to cite the risk of falling prices to justify another round of unconventional policy measures.

MANUFACTURING SLOWDOWN

According to the ISM, 35 percent of manufacturers reported rising production in June, a slight improvement on the 30 percent who reported a positive trend in May. It was lower, however, than the 40-43 percent who saw production rising in Q1, and not much better than levels recorded prior to previous rounds of easing, at 31-33 percent in Q3 2010 and 20-25 percent in Q2 2003.

The percentage of manufacturers reporting lower output rose to 19 percent, up from 7 percent in March, and about the same proportion as reported falling production in 2010 and 2003. Responses to the new orders part of the survey reveal a similarly subdued picture, suggesting the economy will continue to grow slowly for the next few months.

Other real-time data point to an extended soft patch. The improvement in railcar loadings that began at the start of 2010 appears finally to have run out of steam. Freight hauled on major Class 1 railroads was significantly below prior-year levels in the week ending July 9 for the first time since February 2010.

Volumes were distorted by the July 4 holiday, and much of the decline in recent months can be ascribed to falling coal shipments, as cheaper natural gas displaces coal in power generation. But it is clear the rise in freight traffic is tapering off

http://graphics.thomsonreuters.com/ce/FREIGHT.pdf

HOPE RATHER THAN EXPERIENCE

Policymakers and private forecasters continue to talk up prospects for faster growth in the second half and into 2012, but that looks like an aspiration rather than a prediction. None of them have explained why growth will accelerate, beyond saying that one-off negative factors in H1 (Libya, rising oil prices and Japan's earthquake) are unlikely to be repeated.

Fed Chairman Ben Bernanke and his closest colleagues insist the economy's problems are cyclical rather than structural, implying the answer to further weakness is more monetary accommodation (fiscal stimulus is now off the table for political reasons).

But at some point prolonged cyclical weakness starts to look more like a structural problem. Faster growth depends on business and consumer confidence in the durability of the recovery; a willingness on the part of the business sector to undertake speculative investment in plant and machinery, and households to borrow.

But confidence remains low, and there is no reason why households and firms should become more optimistic in the near term given the poor outlook for employment, wage growth and prices.

At present, there is no reason to expect the economy's performance will be much better in H2 2011 and H1 2012. It seems likely most forecasts will be adjusted downwards in the coming weeks to show continued sluggish growth as their baseline scenario.

In prepared remarks last week, Federal Reserve Bank of Boston President Eric Rosengren acknowledged slow growth has been the norm in the current recovery.

"The only quarter of strong growth so far in this recovery has been the one containing the holiday season at the end of last year."

Rosengren went on to argue: "With housing activity and government spending likely to continue to be unusually weak for a recovery, we need consumer and business confidence to improve so that consumption and investment can offset the weaker growth in other components of GDP."

http://www.bostonfed.org/news/speeches/rosengren/2011/071311/index.htm

Rosengren has supported aggressive monetary responses to what he sees as cyclical rather than structural weakness. But he is right that the pace of growth will not accelerate without more confidence, which has so far been conspicuous by its absence in this recovery.

It is hard to see why that is set to change significantly in the next six months. Forecasts for growth and commodity consumption may therefore need to be marked down in the coming weeks to reflect more realistic expectations about growth in the United States and other advanced economies in the remainder of the year and into 2012.

Ends --

By John Kemp, Reuters market analyst – for Commodities Now.

The views expressed here are his own.