Recession Fears Fade But Euro Debt Crisis Still Looms

Third-quarter GDP numbers are encouraging, but the uptick might be temporary

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After a shaky start to the third quarter, the economy has found firmer footing, avoiding the double-dip recession that seemed imminent this summer. But don't celebrate just yet—economists still expect a long, hard slog to a sustained economic recovery.

Stronger-than-expected retail sales data in September and improving labor market conditions fueled the more positive outlook, and while still relatively weak, business spending and manufacturing have kept up despite volatility in financial markets.

Projections for GDP growth in the third quarter are now estimated to be as high as 2.7 percent, a welcome improvement from the measly 1.3 percent the economy posted in the first quarter, and a long way from the 1.5 percent economists expected just weeks ago.

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But much of the pickup in growth could be temporary, experts say, reflecting the dissipating disruption to the supply chain in auto production after the devastating March earthquake in Japan, according to Reuters. Declining gasoline prices have also supported better third quarter growth, giving consumers a little more breathing room in their budgets and strengthening consumer demand.

"Some of those are temporary boosts to growth; consumer spending is going to be sluggish and housing still flatlined," says Nariman Behravesh, chief economist at IHS Global Insight and author of Spin-Free Economics. "Starting in the fourth quarter on for about a year, probably the best we can hope for is about 1.5 percent growth—still no recession, but very weak growth."

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Forecasts for job growth aren't too rosy, either. Behravesh expects the economy to add 50,000 to 100,000 jobs a month, certainly not terrible, but not great either, he says. Most economists agree the economy needs to add upwards of 200,000 jobs per month to make any meaningful dent in the sky-high unemployment rate, currently at 9.1 percent.

"This really is a lost decade for the U.S.," Behravesh says. "We're about halfway through a lost decade and we still have a ways to go."

But the crisis with the potential to cripple the U.S. economy the most isn't even within in our borders. "There is no question that the European debt crisis is, at this point in time, the single biggest threat to the United States," he says. "If [policymakers] can come up with a decent solution, then I think we muddle along as we've said. If they don't and there's some kind of meltdown in Europe, that could really hurt us."

Progress toward a solution, albeit moving at a snail's pace, has placated markets for the most part, but experts are uncertain how long European policymakers can drag their feet on addressing the euro zone's debt crisis and banking sector issues before financial markets react negatively. According to the Financial Times, European leaders have less than a week to resolve key differences on a comprehensive plan to end the euro zone sovereign debt crisis. Experts say the euro zone is still some way from an agreement, and G20 finance ministers and central bankers gathered in Paris this past weekend urged policymakers to act.

In the U.S., the ripple effects of a political and financial failure in Europe could be widespread. Banks would likely take a hit due to their exposure to European markets, which could further tighten credit, already crimped for consumers and businesses alike.

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U.S. companies that do business with Europe would likely suffer, especially those with large operations in the region. Exports could take a hit as well if demand from European countries drops and the dollar strengthens against other currencies.

As much as troubles across the pond cast a dark shadow over the U.S. economy, underlying changes in consumer spending are likely to persist at home as the uncertain economic climate pushes Americans to spend less, save more, and pay down debt. While that's good in the long term, it means consumers will continue to hold back on spending—bad news for retailers as the holiday season approaches and an unfavorable overture for the economy going into the fourth quarter.