The risks to the U.S. economy are high, and not yet fully reflected in asset prices, warns BMO Nesbitt Burns Chief Economist Sherry Cooper in a research note.

In a note published Friday, Cooper writes “U.S. growth is likely to continue at about a 3% pace for the remainder of 2005 and 2006, but it is vulnerable to further unexpected disruption.”

Cooper notes that while U.S. Federal Reserve Board Chairman Alan Greenspan has been quite successful in maintaining stable growth, his term ends in four months.

“With the approval ratings of [U.S. president George W. Bush] falling to the lowest level during his term in government, and even Republican support eroding at least a bit, politics will play a significant role in fiscal decisions. Risk is high and not fully reflected in asset prices,” Cooper warns.

In a report of its own, UBS Securities LLC says that the statement released by Fed officials following the September 20 meeting was relatively hawkish, signaling more concern about the inflation than growth implications of rising energy prices. “They seem prepared to keep tightening even if near-term growth data show weakness,” it observes. “We now forecast a 4.25% funds rate at year-end, instead of 4.0%.” It then sees the rate hikes on hold in 2006.

BMO Nesbitt’s Cooper agrees, “The language of the Fed’s September 20th press release suggests that another rate hike will come at the November 1st meeting, with yet another 25 basis point hike possibly in the wings for December or, more likely, the January 31st meeting, the last one for Mr. Greenspan.”

Of the risks though, Cooper observes, “The rise in gasoline prices and heating costs is a tax on growth.” Also, she argues consumers are already heavily indebted with no active savings, and while home ownership is close to a record-high 69% of households, “many sub-prime borrowers and others are living in homes they can barely afford”.

“While household net worth is 5.5 times income, a high level by historical standards, much of the run-up in wealth since the stock bubble burst in 2000 was due to the hefty rise in median house prices over the period,” Cooper writes. “Many cashed out some of this gain with massive mortgage refinancing and home equity loans. Nevertheless, equity remains high, at least on paper. But, active savings provide a cushion of liquid assets for a rainy day; judging from multi-year data, even after considering statistical distortions, little active savings are evident, so consumers are vulnerable.”

The U.S. federal government, as well, is a net debtor and that debt is about to rise meaningfully with the estimated US$150 billion to US$200 billion costs associated with hurricane Katrina, Cooper adds. “While the White House is unwilling to consider tax increases, and the Congress is unlikely to cut government program spending, the federal budget deficit will rise. It’s a good thing that foreign investors are so keen to acquire Treasuries, because there will be plenty to go around.”