The main obstacle standing in the path of faster U.S. economic growth is a strong headwind blowing in from fiscal restraint, according to a report released today by TD Economics, an affiliate of TD Bank.

"Without fiscal drag, the U.S. economy would be headed for a growth trajectory in the 3-4% range in 2013," says TD chief economist Craig Alexander. "The worst of the consumer deleveraging cycle and its dampening effect on economic growth appear to be over. But just as the private sector is set to provide a welcomed tailwind to the economy, it will be met with worsening cross winds from public sector restraint."

Alexander acknowledges that the result is likely to be a pace of economic growth that is little changed from the past year.

TD Economics forecasts economic growth to average 1.9% in 2013 – down from an estimated 2.2% in 2012. However, by the second half of next year, clearer fiscal policy should lead to resurgence in private demand, placing the economy on a stronger footing with 3.0% growth in 2014.

Still Waiting for a Path Around the Fiscal Cliff

With a few weeks to go before deep spending cuts and tax hikes arrive and hamper economic growth, a deal to avoid them between the White House and Congress has yet to be reached.

"The fact that businesses are pulling back on investing, despite healthy balance sheets and record low interest rates, is a sign that fiscal cliff concerns have already taken a toll on economic growth," notes Alexander.

TD Economics estimates that if all tax hikes and spending cuts are allowed to take place as scheduled, it would cut 3.0 percentage points from real GDP in 2013.

"Our forecast assumes a deal will be made that avoids plunging the U.S. economy back into a recession in the first half of 2013," says Alexander. "However, spending restraint and tax increases will still cut economic growth by 1.3 percentage points in 2013," Alexander warns that until there is more clarity on the political front, the fiscal situation represents the largest source of economic uncertainty.

As Housing Rebounds, Faster Growth Is Waiting in the Wings

The constraint on growth posed by fiscal policy comes amid signs that housing has entered a self-sustaining recovery. Home prices have risen consistently through 2012 while delinquencies and foreclosures have fallen.

The rise in home prices has been substantial – prices are up 5.0% from year-ago levels – and appears sustainable. The fall in construction activity over the last several years has cleared the supply overhang and allowed rising demand to pull up prices.

"A strengthening housing market recovery alongside rebounding consumer credit markets is a good reason to expect acceleration in economic growth," says Alexander. "The past vicious cycle in the housing market is turning into a virtuous one, giving every reason to believe that a more familiar recovery will spring free."

The Federal Reserve is Doing Everything it Can to Support Growth

The housing market has also been the focus of the Federal Reserve, whose latest round of quantitative easing has focused on purchases of mortgage-backed securities.

"The Fed has pulled out all the stops to support the recovery in housing and offset some of the drag from fiscal policy," notes Alexander. "But, as several Fed members emphasized, monetary policy can provide some relief, but it can't single-handedly offset the fiscal headwind."

"A clearer path to fiscal consolidation alongside continuation of accommodative monetary policy will be the necessary cocktail for stronger economic growth in 2014," concludes Alexander.

TD Economics provides analysis of global economic performance and forecasting, and is an affiliate of TD Bank.

Read the complete findings of the TD Economics Report.