Eurozone debt crisis a drag on recovery and Obama's campaign

A stock sell-off driven by renewed worry over Europe made clear Monday that the continent’s debt crisis remains a threat to the U.S. recovery and President Obama’s reelection chances.

Markets were spooked Monday morning by the news that multiple regions of Spain, and not just the nation’s banking system, might need a bailout. Adding to the gloom was a report that Greece could lose its bailout lifeline if it fails to effect certain reforms, an outcome that could shatter the eurozone. 

The quick reaction in the markets indicates Europe will continue to be dead weight on the U.S. recovery and a problem for Obama, whose bid for a second term could hinge on how voters feel about the economy.

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The Dow Jones Industrial Average shed roughly 200 points in the first moments of Monday’s trading before recovering to close the day down about 100 points. The Nasdaq and S&P 500 experienced similar drops as officials in Spain and Italy issued bans on short selling to try and tamp down the frenzy.

The political strife fueling Europe’s debt crisis is showing few signs of abating, with most expecting it to remain a dark cloud over financial markets at least through the November election, if not longer.

“The European situation is just going to take a really long time to resolve — years,” said Ed Friedman, a director at Moody’s Analytics. “In the U.S., we have one government, one currency, one language … and yet look how difficult it is for us to figure out what to do.”

As if foreign challenges were not enough, there is growing concern that the U.S. recovery could be stalling. After adding an average of 226,000 jobs in the first three months of the year, the last three jobs reports have been a disappointment, showing gains of just 75,000 per month.

The latest data on the manufacturing front are similarly bleak. The business activity index from the Philadelphia Federal Reserve Bank found factory output in the Mid-Atlantic region had declined for three straight months.

The run of disappointing data has led Wall Street to pare its expectations for U.S. growth. A slew of large financial firms, including Goldman Sachs and Deutsche Bank, responded to the data by trimming immediate expectations for economic growth in the coming quarter. 

In a research note issued Friday, Goldman’s research team noted that economic data “deteriorated in recent months,” and the firm now expects the economy to grow slightly more than 1 percent in the second quarter. The Commerce Department will release its first estimate of second-quarter growth on Friday.

The uncertainty over how lawmakers will deal with the “fiscal cliff” of automatic spending cuts and tax increases set to take effect in 2013 is further weighing on the recovery. 

“By itself, the economy is not headed into a recession, but of course there are risks that could drive it there,” said Friedman. “It’s not really strengthening the way the U.S. economy ordinarily does.”

One bright spot for the president can be found in the swing states, where the jobs picture is a touch rosier. New data released by the Labor Department on Friday showed that a number of battleground states have an unemployment rate lower than the national average of 8.2 percent.

Ohio’s jobless rate, for example, dropped 0.1 percent in June to 7.2 percent, while Virginia’s stood at 5.7 percent. 

The labor market in the swing states of Nevada and Florida, however, is weaker than that national average, with unemployment rates of 11.6 and 8.6 percent, respectively. All told, slightly more than half of all the battleground states reported an increase in the unemployment rate in June.

Another encouraging sign for Obama can be found in the housing market, which has long served as a drag on the recovery. Recent data on the amount of homes being built in the United States, as well as the trajectory of prices, suggest the long-troubled housing market is turning a corner.

The Commerce Department reported Wednesday that new construction on homes had climbed 6.9 percent in June, as the construction of single-family homes reached its highest level in over two years. New housing permits for single-family homes also climbed, even as new permits overall dipped 3.7 percent. 

When combined with historically low interest rates and prices that appear to be stabilizing, housing advocates say the time is right for a turnaround.

“We’re by no means home free, but conditions are right for us,” said David Krowe, chief economist at the National Association of Home Builders.

But housing isn’t immune from the broader challenges facing the economy.  

“If we continue to see poor job performance, poor job growth, it will put a dent in housing,” said Krowe. “There’s no question there continues to be hurdles out there.”