U.S. Economy Maintains Momentum As Fiscal Headwinds Increase

  • The federal spending sequester took effect March 1. The $85 billion reduction in federal defense and nondefense discretionary spending for FY2013 is expected to exert about a 0.6 percent drag on real GDP growth for 2013. This adds to the fiscal tightening already in place due to the expiration of payroll tax cuts and the increase in income, capital gains and dividend taxes for top income earners. It is speculated that cuts to defense contracts will be felt most by subcontractors rather than primary contractors. The good news is that the potentially severe impact of the sequester has been reduced with smaller tax increases than originally feared and a more spread-out timetable. The analogy of a “fiscal slope,” as opposed to a “fiscal cliff,” may be the most appropriate at this time.
  • Several fiscal risk factors remain. The federal budget process is dysfunctional. The debt-ceiling limit was kicked down the road until May. The U.S. Treasury may employ special measures to continue funding the federal government until sometime in July. We may see more tax increases and spending cuts this summer as a result of upcoming budget negotiations. Also, entitlement reform is necessary in order to achieve long-term fiscal stability. Entitlement reform may be bundled with tax reform this summer. Further downgrades by rating agencies of the U.S. debt now appear likely if fiscal negotiations fail to yield significant results. If downgrades are limited they will not significantly reduce demand for U.S. treasury bonds. However, a series of downgrades could eventually weaken demand for U.S. debt, resulting in higher interest payments on our national debt (more on this on page 2).
  • The antidote to fiscal tightening is job growth. Fortunately, labor market data for February was better than expected, showing a solid gain of 236,000 payroll jobs for the month. Also, the average workweek increased a tenth to 34.5 hours, and average hourly earnings increased by 0.2 percent in February. Not only were more workers hired, but they also worked longer hours and got paid more, which will lift both production and income numbers for February. The unemployment rate fell from 7.9 percent to 7.7 percent which is the lowest it has been since December 2008.
  • Anecdotal reports suggest that increased taxes and higher gasoline prices added stress to low and middle income household budgets in January and February. However, auto sales firmed in February to a 15.3 million unit annual pace, showing that households are still willing to take on additional debt to finance new autos. Increasing house prices are helping to shore up consumer spending. As of 2012Q4, homeowners were building equity at a robust 25 percent year-over-year rate according to the Federal Reserve.

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Click here for the complete March 2013 U.S. Economic Update: USEconomicUpdate0313.

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