The US economy continues to show resilience despite uncertainty from the upcoming fiscal cliff. Private consumption has strengthened due to improvements in the housing market and labor market. However, business investment and hiring remain constrained by policy uncertainty, particularly regarding how the large budget deficit will be addressed in the long run. If major fiscal policy issues can be resolved decisively in 2013, businesses may increase spending and hiring to boost economic growth. But continued uncertainty risks prolonging the current sluggish recovery.

1. MARKET SENSE 1 November 2012
Hard to kill
 Today’s data confirm that the US economy is hard to kill. Private consumption has found a
second wind, helped by the stabilization in the housing market: it pulled us out of the summer
slump, and seems set to carry us into the new year.
 Uncertainty on the policy outlook, however, holds back investment and hiring. The fiscal cliff is
the most obvious source of uncertainty, but underlying it is a substantial medium-term fiscal
challenge that needs to be addressed. If major policy uncertainty is resolved in a decisive and
speedy manner in 2013, then US businesses should be able to take the baton from consumers.
The external environment should help as well: by mid next year, emerging markets should
show stronger strength after the recent cyclical weakening. Kicking the can down the road, on
the other hand, could be very costly.
 The US economy has the flexibility and the innovation potential to get back on a fast growth
track, but for that to happen, there are important challenges to be addressed on both the
fiscal and structural side. The sooner the better.
Today’s data confirm that the US economy is hard to kill. It continues to defy the doomsters’
predictions of inescapable collapse (a year ago, high profile experts declared that the US was already
back in recession). A sober assessment of the data is especially difficult with just a few days to go before
Election Day, but it extremely important to understand what possible economic scenarios await us in
2013 and gauge both downside and upside risks.
Consumer confidence continued to rebound in October, and the Conference Board index reached the
highest level since February 2008. The University of Michigan confidence index shows a very similar
picture. The positive trend in consumer confidence matches the dynamics in retail sales, which rose over
4% year-over-year in October. This is still a relatively brief recovery form the summer slump—but we got
a rebound rather than a deepening downturn. The tragic and disastrous impact of hurricane Sandy on
the US East coast will undoubtedly worsen some of these indicators in the next couple of months, but is
unlikely to change the underlying nation-wide trend.

2. MARKET SENSE 1 November 2012
Housing and jobs are the main factors behind the stronger consumer confidence. Evidence that the
housing market has bottomed out and started a gradual recovery gets more convincing every month.
Only a slow and gradual improvement, but an improvement: housing is no longer a headwind to the
recovery. Initial jobless claims declined this week, beating expectations, and confirming the picture of a
slow firming up of the labor market. The pace of job creation is disappointing, and I remain of the view
that the labor market weakness has a bigger structural component than the Fed seems to think.
The improved trends in consumer confidence and consumption are consistent in principle with a
troubling entrenched dichotomy between the haves and the have-nots in the labor market: on one
side, people who have the right skills and are now less afraid of losing their jobs; on the other people
who still find themselves shut out of the labor market. Data on voluntary separations (workers resigning
to pursue other opportunities) and indications of increased labor mobility seem to point in the same
direction—a reminder that skills and education will play a more and more important role in employment
trends as we go forward. Narrowing this dichotomy is key to prevent a deterioration in the potential
growth rate of the economy.

3. MARKET SENSE 1 November 2012
Business sentiment as measured by the manufacturing ISM also improved, rising for the second
consecutive month in October. This is another testament to the resilience of domestic consumption,
given that international trade has weakened in the past few months.
Investment and hiring, however, are still held back by the uncertainty on the post-election outlook,
and in particular on how the “fiscal cliff” will be addressed. According to the Washington Post, a study
by the National Association of Manufacturers to be released tomorrow (Friday) estimates that the
Damocles’ sword of the fiscal cliff will have cost us about one million jobs this year—quite a costly
uncertainty ( http://www.washingtonpost.com/business/economy/fiscal-cliff-already-hampering-us-
economy-report-says/2012/10/25/45730250-1ecf-11e2-ba31-3083ca97c314_story.html ). Given the
precedent of last year’s debt ceiling fiasco, it would be prudent to assume that any agreement on the
fiscal cliff will only be reached at the very last moment, and possibly after some of the cliff’s automatic
tax hikes and spending cuts have already been triggered. But in the end common sense should prevail
and almost everyone expects that the bulk of the fiscal cliff will be avoided.
The real issue is that the US’s medium term fiscal picture looks precarious, and will eventually require
some tough decisions. On current legislation, the Congressional Budget Office estimates that debt held
by the public might rise to 200% of GDP by 2035. The bulk of the projected rise is driven by health care
costs, but the current underlying state of public finances is far from healthy, with gross public debt in
excess of 100% of GDP and a fiscal deficit of close to 9% of GDP even as interest payments on the debt
are at exceptionally low levels (2012 IMF projections). There is a wide window of opportunity to act: US
government bonds are still seen as a safe haven, and the projected rise in health care costs can be
addressed without a short-term budget squeeze. Public finances can be brought back on a sustainable
track without draconian growth-destroying measures. But uncertainty is costly, and this is a large
uncertainty to face, especially when compounded by question marks on whether US potential growth
has weakened, and by fears on the external environment.
If major policy uncertainty is resolved in a sufficiently decisive and speedy manner in 2013, then US
businesses should be able to take the baton from consumers. US corporates are healthy, lean and

4. MARKET SENSE 1 November 2012
profitable, with cash to invest and an existing workforce already squeezed to capacity—the conditions
for an acceleration in investment and hiring are in place.
External conditions should turn more supportive by mid-2013. While Europe will still be in the
doldrums, emerging markets should start seeing the impact of the recent loosening in policies. We are
seeing early signs in China, where the pick-up in the PMI index is consistent with a soft landing to a 7-8%
GDP growth rate.
Kicking the can down the road, on the other hand, might be very costly. US consumers are doing a
commendable job at supporting economic growth through the year-end uncertainty, but their balance
sheets are still too weak to fuel a further acceleration into next year. The corporate sector will need to
take a greater role, and better visibility over the economic horizon is essential. Protracted uncertainty
could hold back hiring, undermining the improvement in both consumer and business sentiment,
prolonging the current state of sluggish and fragile economic performance.
The US economy has the flexibility and the innovation potential to get back on a fast growth track, but
for that to happen, there are important challenges to be addressed on both the fiscal and structural
side. The sooner the better.