Budget Agreement, December ISM Manufacturing, Nov. Construction

       Half-Baked Budget Agreement Leaves More to Do, Manufacturing Conditions Improve

  • The ISM Manufacturing Index for December increased to 50.7 percent, indicating slight improvement.
  • Construction Spending for November decreased by 0.3 percent, held down by private nonresidential.

We start out the new year with a little less uncertainty about the direction of federal budget negotiations, but that is not to say that uncertainty has been significantly reduced. On the contrary, the compromise budget agreement passed by the House of Representatives yesterday only removes some of the uncertainty regarding near-term tax policy, while kicking the rest of the can down the road. Most families (estimated at 99 percent of households) will see a permanent extension of the Bush-era tax cuts. However, high earners (above $400,000 for single filers and $450,000 for married couples) will see their income tax rates go up, as well as capital gains and dividend tax rates. The bill permanently indexes the Alternative Minimum Tax, ending the annual ad-hoc recalibration there.  However, most families will feel the bite of higher payroll taxes as the Obama-era payroll tax cut expires. The nonpartisan Tax Policy center estimates that 77 percent of households will pay a higher share of their income to the federal government in 2013. Unemployment benefits will be extended for another year. What remains to be done? Plenty. The bill does not address the soon-to-be-encountered debt ceiling and it does not resolve the federal spending sequester. As a result, we will endure more rancorous political debate over the next two months. The odds of a downgrade of U.S. debt by rating agencies remain elevated.  With only a partial resolution to the entire set of Fiscal Cliff issues in place, we can still only estimate the total fiscal drag that we will feel in 2013. Right now it is reasonable to assume that a significant portion of the $110 billion sequester will happen. It is reasonable to assume that the total fiscal drag from increased taxes and reduced spending will be in the neighborhood of 2 percent of GDP, primarily felt in the first half of 2013. This is in the ball park of our previous estimates, and consistent with an economy that grows very weakly, in the range of 0 to 1 percent GDP growth for the first half of 2013. Needless to say, the economy will likely feel stagnant at that very weak growth rate. Job creation will be modest and the unemployment rate will improve little, if at all. It is also important to note that while the likely final fiscal outcome does not guarantee recession in 2013, the odds of recession in 2013 are high. The U.S. economy has many positives going for it. But a 2 percentage point reduction in GDP growth is a gut shot that would stagger even a healthy economy. Add to the still remaining fiscal uncertainty the phasing in of Obamacare in 2013 and the uncertainty meter has to remain stuck at high for the next few months.

The first major U.S. economic data point of the new year was positive. The ISM Manufacturing Index increased to 50.7 percent, indicating a modest improvement in manufacturing conditions. The employment index improved from contractionary to mildly expansive at 52.7. Construction spending in November dipped by 0.3 percent, as private nonresidential spending fell 0.7 percent.

Market Reaction: U.S. equity prices opened sharply higher. Treasury rates are up at the long end of the yield curve. Oil is up to $92.97/barrel. The dollar is up against the yen and the euro.

Click here for a PDF version of the Comerica Economic Alert: ISM-MF 010213.

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