By John W. Schoen Senior producer
updated 8/13/2010 6:10:27 PM ET 2010-08-13T22:10:27

The outlook for the U.S. economy just went from half-full to half-empty.

Major Market Indices

The latest economic data out this week confirmed a gloomier forecast issued by the Federal Reserve Tuesday after its regular rate-setting meeting. That has renewed fears of a so-called “double-dip” recession that are weighing on investors, spooking consumers and slowing businesses from hiring.

Many economists argue that a recovery, slow but steady, is still intact. But growth forecasts are falling, and the odds of another contraction are rising.

“The next couple of months or quarters will determine whether the economy double-dips or whether it actually picks up a little momentum,” said Stuart Hoffman, chief economist at PNC Financial.

After a surge in growth late last year and in early 2010, the government estimated last month that gross domestic product grew at a 2.4 percent in the second quarter, down from 3.7 percent in the first three months of the year.

But fresher data suggest the economy may have barely grown at all in the quarter, and early results from the current third quarter are not too encouraging. As a result a midsummer stock market rally was abruptly halted this week and the stock market reversed course, dropping about 4 percent in just a few sessions.

One troubling indicator came Wednesday, when the Commerce Department reported that the U.S. trade deficit widened in June, as imports surged and exports fell. Economists at Barclays’ Capital told clients the report suggested that GDP growth for the second quarter might be revised to as low as 0.3 percent.

Meanwhile the painfully weak job market shows no signs of improvement. The economy has added a paltry 650,000 jobs this year and the official unemployment rate remains at a recessionary 9.5 percent. A report Thursday showed that first-time claims for jobless benefits rose in the latest week to 484,000, the highest total since February.

The lack of job growth has put a damper on consumer spending, which still accounts for about 70 percent of GDP and typically drives economic recoveries.

On Friday, the government reported that retail sales edge up in July but mainly due to a rise in gasoline prices. A separate survey on consumer sentiment showed that few of them expect to see the economy improve in the months head.

Though consumers continue to pare down debt, they’re still struggling to pay off the huge borrowing spree of the past decade.

"We've already taken a trillion dollars of household debt out of the system, either written down, walked away from, or modified," said David Rosenberg, chief economist at the investment firm Guskin Scheff. “But there's another $6 trillion to go."

Housing has historically played a major role in economic recoveries, but both housing construction and home sales remain sluggish even though mortgage rates have fallen to record lows and continued to fall.

There is little incentive for builders to build, especially because the flow of home foreclosures shows little sign of abating.

Banks have stepped up repossessions this year to clear out the backlog of bad loans, pushing the foreclosure rate higher for eight straight months and creating a huge backlog of unsold homes. Gary Shilling, one of the more bearish market analysts, estimates that there are 2.5 million surplus homes on the market, more than five times the current rate of new construction.

“It will take a long time to absorb that,” he said. “And excess inventories are the mortal enemy of prices. It's that simple.”

Investors retrench
Investors don't have a sense of whether the recovery will hold. The uncertainty has led to big losses, but many traders are staying out of the market and not making any moves. That has made trading volume even lighter than usual during July and August, when vacations leave trading desks thinly staffed.

After a steep slide this spring, the stock market regained its footing and enjoyed a healthy midsummer rally based largely on strong second-quarter corporate profits. But the profits have been built largely on increased productivity, not stronger sales. And investors are beginning to grow nervous about whether those gains are sustainable.

On Tuesday, the Labor Department reported that worker productivity dropped 0.9 percent in the second quarter – after rising for five consecutive quarters. Technology investment may also be taking a breather; on Thursday technology stocks led a sell-off after second-quarter profits from computer networking giant Cisco came in weaker than expected.

Company CEO John Chambers warned of a slowdown in technology spending, telling analysts the company is getting “mixed signals” from customers.

“Their earnings on most cases are doing better,” he told CNBC. “They're growing, but they're hesitant about hiring."

Even as the growth is slowing in the U.S. there are signs that other major economies may also be cooling. On Friday, European officials reported the economy there grew 1 percent in the second quarter, thanks to a surge in German exports that many forecasters believe will be hard to sustain. The Euro weakened in relation to the dollar this week over renewed concerns about the European economy.

Though China’s economy continues to surge ahead, the latest monthly data on industrial production, retail sales and bank lending all pointed to a gradual slowdown.

"They have been the anchor of global growth,” said Laurence Meyer, vice chairman of Macroeconomic Advisers and former Fed board member. “It's not just China. It has a multiplier effect, because as China goes, so Asia  goes, and Asia is very important to the U.S. I think it will be very damaging to psychology, very damaging to  market psychology if it turns out that China is slowing.”

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