Impact of Sequestration on Markets and the Economy

I think we have to have some legitimate concerns about the potential impact of the legislated sequestration on markets and the economy as a whole. Our nascent economic recovery has come in large part due to the largesse of government spending in the absence of private sector consumption. Pulling on the government purse-strings too hard today while unemployment (not to mention underemployment) remains high creates some serious risks for growth in 2013 – both in the US and abroad. Here’s what we’d like to see and how we expect things to actually play out:

Bernanke Advocates for Muted Near Term Spending Cuts

It comes as no surprise that we are falling on the side of Fed Chairman Ben Bernanke on this topic. Based on his testimony before Congress the other day, the Fed Chairman advocates making cuts to the budget near term smaller and put more emphasis on budget tightening perhaps as far as 10 years out. I can find little fault with that argument. The key in any attempts to manage any economy is knowing when to step on the gas and when to ease off. I think the Chairman would much rather be sitting in a position where the Fed could reduce its stimulative efforts however the unwillingness of the Congress to step in to increase spending has left the central bank no choice – if we all want to avoid catastropic economic contraction. One wonders if there are some in Congress who would prefer contraction. It sure seems that way.

How We Expect Sequestration to Play Out in Congress Over the Next Few Days

In a few words – sequestration is coming. Based on the game of chicken Representative Boehner and Senator Cantor continue to play with Senator Reid and Representative Pelosi played with the Bush Tax cuts around the turn of the new year we can only expect the same waiting game again. Given there is so little time before the cuts take place it would seem that we may go several days into the mandatory cuts before the impacted agencies start screaming at the reps to come to agreement. We fully expect the military to put considerable amounts of pressure on the GOP led House to make some concessions at the bargaining table to buy time to adapt to the changing budget expectations. It only stands to reason: no one wants to be the guy that guts the military spending or the important social programs allowed for in the budget. It also isn’t particularly fair (or reasonable) to expect government departments to turn on a dime and cut spending – even though most departments should have expected to make sacrifices already during these long months of debate and the election cycle.

Personally I remain optimistic about Congress’ ability to act. They will not likely meet the deadline – causing some minor disruptions in many departments in the government – but once resources truly become scarce the debate will get very heated and finally there will be some resolution – presumably closer to the Fed Chairman’s recommendations than the ill-advised GOP led House budget proposals.

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