- U.S. – TIME IS UP: LET THE CUTS ROLL
After a two-month delay, the time for sequestration has finally come. Equity markets took the news in stride, having already anticipated that Congress would not bridge the gap before today. At the time of writing, President Obama was scheduled to meet with top members of the House and Senate to discuss how best to proceed on both revenue and expenditure related issues. At this point, the chances of another last minute deal to come out of this meeting are slim to none. If the past is any indicator of the future, President Obama will most likely make another push for a delay or reduction in spending cuts combined with a closing of loop holes and other deductions. Republicans will undoubtedly dismiss any such proposals, remaining steadfast on their position to further increases in revenue. The end result, continued stalemate in Washington.
Although sequestration officially kicks in today, the effect is already being felt. Fourth quarter GDP revisions which were released yesterday morning showed that the U.S. economy grew by a paltry 0.1% (annualized) in the final quarter of 2012, as opposed to the initially reported -0.1% (annualized) contraction. The revision disappointed relative to market expectations for growth of 0.5% (annualized), with government spending being one of the main culprits – subtracting a sizeable 1.4 percentage points from the tally.
The question now is: how much more of a drag can we expect? Sequestration will result in $85 billion dollars of cuts to the budget authority over the remaining 2013 fiscal year, and a total of $1.2 trillion over the next ten years. However, not all of the $85 billion in reduced spending authority will result in actual spending cuts this year. Because outlays can carry over from previous years, departments will be able to offset some of these cuts. In fact, the Congressional Budget Office (CBO) estimates that outlays, due to sequester, will fall by only $44 billion in the 2013 fiscal year. This equates to a 4.6% reduction in outlays over the remaining fiscal year that will be split evenly between discretionary defense and non-defense spending.
Unlike the fiscal cliff, the effects of the sequestration will not be felt immediately. Rather, the $44 billion in cuts to outlays will slowly be introduced over the course of the next seven months. Barring any further negotiations from Washington, the drag on real GDP during 2013 could be as large as 0.6 percentage points. While the impact of the sequester alone is not catastrophic, it is coming atop of a depressed economy that has struggled to find traction since the recent tax increases – a by-product of the American Tax Payer Relief Act of 2012.
At this point, changes to our GDP forecast will be modest (-0.1 percentage points), as we had already assumed considerable fiscal consolidation following the January tax-deal. While there is a possibility that sequestration is here to stay, there is also a chance that the House and Senate could succumb to mounting public pressures over the coming months to reduce or eliminate it. Ideally, a deal to reduce sequestration would consist of a credible long term plan to shrink the deficit through a combination of revenue increases and more carefully directed cuts to discretionary spending.
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