Good calls in September would soon pay off

September will be a pivotal month for the U.S. economy. Violence in the Middle East, fiscal battles in Washington, and a key Federal Reserve decision about monetary policy all loom on the calendar. It could be a messy and difficult month, but if these issues are resolved reasonably, growth and job creation will soon kick into a higher gear. If not, the pace of recovery will continue to disappoint.

The Middle East has long been a drain on U.S. growth. The wars in Iraq and Afghanistan have been extraordinarily costly. Syria's chemical-weapons attack and the coup in Egypt are the latest worries. If these conflicts spill over to the rest of the region and disrupt oil production, we will have a serious economic problem.

Oil markets are appropriately jittery. Crude prices have risen almost $10 per barrel since violence in Syria and Egypt escalated; if the current level is sustained, it will add about 25 cents to the cost of a gallon of gasoline.

This would be merely a nuisance, but if the unrest spreads to Iraq, Iran, or Saudi Arabia - countries that produce lots of oil - prices will go much higher. The United States is less sensitive than it once was to swings in energy prices, thanks to the growth in domestic shale oil and natural gas production, but it still hurts when global energy prices jump.

Events in the Mideast are hard to predict, but the most likely scenario is that turmoil in the region will continue but remain largely contained, at least for a while.

Meanwhile, Washington is due for another major political battle after Congress returns from its summer break. Once again, the debt ceiling will provide the spark. The federal government is nearing its current statutory limit on the amount of outstanding Treasury bonds. Since the government is running a large deficit - more than $600 billion this year - the national debt continues to mount.

Unless the ceiling is increased, the government will soon have no choice but to reduce spending severely. To shirk payments to investors in Treasury bonds would rock global financial markets; the only alternative is big cuts to government programs. Even the defense budget would be slashed, and Social Security recipients might receive only partial benefits.

Washington must also come to terms on how much the government can spend after its current budget authorization runs out at the end of September. Without legislation that extends the government's spending authority, the government will shut down. A shutdown won't damage the economy if it lasts three or four days, but it will if it lasts three or four weeks.

We've seen this movie before, and each time, the party deemed responsible for the shutdown has paid a significant political price. The coming negotiations will be unseemly and will continue until the final hour, but faced with the consequences, policymakers should come together.

The Federal Reserve is also expected to make a big decision in the next few weeks. Since the Great Recession began almost six years ago, the Fed has been pressing hard on the monetary accelerator, lowering short-term rates effectively to zero, and buying trillions of dollars in bonds to lower mortgage and other long-term rates.

With the economy healing and the benefits of its bond purchases fading, the Fed is eager to begin unwinding its easy-money policy. Fed Chairman Ben Bernanke has suggested this could start as soon as - you guessed it - September.

Yet even the thought of a Fed pullback has given bond investors heartburn. Long-term interest rates have risen sharply in response. Thirty-year fixed rates for mortgages have gone up more than a percentage point in the last several months. Housing activity already appears to be slowing, which matters a lot to the broader economy's recovery.

Further complicating matters, Bernanke apparently plans to leave when his term is over early next year. There are good candidates to replace him, but uncertainty about who will be chosen and how monetary policy might change as a result is a bit unnerving.

It won't be easy for whomever takes the helm at the Fed to gracefully unwind the policies established by the central bank when the economy was reeling. Pushing interest rates higher without upending housing and the economy will be a difficult trick. But the Fed has the tools it needs and the will, so the odds are it will pull it off.

Uncertainty has cast a pall over the economy. Businesses have been reluctant to hire and invest more aggressively. The entrepreneurial "field of dreams" mentality - build it and they will come - that is central to stronger economic growth has been dormant since the recession.

Unfortunately, September will be another uncertain month. But with just a modicum of sensible policy-making and a bit of luck, the uncertainty should lift by year's end, freeing the economy for a better 2014.


Mark Zandi is chief economist of Moody's Analytics. Contact him via help@economy.com.