By Steven K. Beckner

(MNI) – The U.S. economy is apt to experience another year of
“restrained” expansion coupled with weak employment growth and modest
inflation in 2012, but even that fairly gloomy outlook is subject to
downside risks, according to analysis released Tuesday by the Atlanta
Federal Reserve Bank.

Atlanta Fed President Dennis Lockhart, who will be a voting member
of the Fed’s policymaking Federal Open Market Committee this year, will
speak twice next week. In the meantime, his economics staff is taking a
very cautious view of the year ahead in the Bank’s just-released
EconSouth publication.

“Atlanta Fed economists anticipate that the process of financial
deleveraging within most sectors of the domestic economy will continue
to play out, and this paying down of debt is likely to restrain the pace
of expansion in 2012 and beyond,” writes Laurel Graefe, a policy
specialist in the Atlanta Fed’s research department.

“In addition, a weaker European economy and shifts in the growth
and composition of emerging economies is likely to restrain demand for
U.S. exports in the coming year,” Graefe continues. “Relatively high
unemployment and a slow pace of employment growth along with little
improvement in housing markets are likely to weigh on the confidence of
households, and these factors will hold back consumer spending and the
expansion plans of business.”

“Confidence will return only as the expansion proceeds and the
various economic headwinds dissipate,” Graefe adds.

Graefe writes that “though modest improvement is likely, it appears
that growth will continue to be restrained through 2012.” Meanwhile,
“inflation is likely to return to the 2% range, consistent with the
FOMC’s objective.”

However, “the economic outlook comes with a number of risks,”
Graefe warns. “Most economists’ assessments of the risk to the growth
and employment outlook are weighted to the downside.”

“Volatility in financial markets, slow jobs growth, and weak
consumer confidence make the economy vulnerable to any number of adverse
shocks coming from Europe or elsewhere,” Graefe goes on.

Graefe calls the inflation prognosis “sanguine” because “the
potential for resource slack in the economy placing further downward
pressure on inflation expectations is roughly balanced by the risk of
upward pressures from commodity prices or other influences supporting
inflation expectations.”

Writing in the same publication Atlanta Fed researcher Andrew
Flowers foresees financial storm clouds continuing to hang across U.S.
and global markets, as the European debt crisis compounds the United
States’ own fiscal burdens.

“Financial spillovers from the European crisis figure prominently
in the most severe negative scenarios for U.S. financial markets,”
Flowers writes. “If financial pressures on European sovereigns continue
to escalate, global credit markets could freeze up.”

“European financial institutions with large exposures to troubled
economies would come under intense scrutiny, leading to negative effects
in the United States,” he continues. “The likelihood of such a financial
shock is causing market participants to be risk-averse. And as investors
hedge against various negative scenarios-by seeking safety in U.S.
Treasuries and gold and by selling riskier assets such as stocks and
corporate bonds — U.S. financial markets are suffering from much higher
volatility.”

On a brighter note, Flowers says “The U.S. financial system should
be in a better position to withstand a financial shock than in the past”
since “banks have made progress in deleveraging from the high debt
levels they had before the crisis, and their levels of capital are now
higher.”

“However, the deep interconnections embedded within the financial
system remain a concern,” he warns. “These concerns include counterparty
risk in certain wholesale funding markets, the clearing of derivatives
contracts in the wake of a large default, and the potential for acute
liquidity pressures on institutions outside the traditional banking
system, such as money market mutual funds.”

** Market News International **

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