Partial Deal: Perspectives on the U.S. Fiscal Policy Agreement
January 6, 2013
of Janus Capital Group
The U.S. Congress and President Barack Obama have patched together a deal that avoided the January 1 fiscal cliff. However, Washington has postponed a full resolution of fiscal and tax issues, creating continued uncertainty that can be expected to weigh on business and consumer spending and potentially keep U.S. gross domestic product growth below 2% in 2013.
A half-baked measure
In the 13th hour, Washington lawmakers pulled together a deal that avoided the fiscal cliff. However, it postpones a full resolution of U.S. fiscal and tax issues. As a result, uncertainty can be expected to continue to weigh on business and consumer spending, potentially keeping U.S. gross domestic product (GDP) growth below 2% in 2013.
Congress did accomplish some things: it extended most of the expiring tax rates and delayed across-the-board government spending cuts. Without the agreement, steep military and domestic government spending cuts would have begun on January 1, 2013, potentially pushing the U.S. economy into contraction in the first quarter and recession in the first half of the year.
However, Congress failed to accomplish other goals. The agreement only delays across-the-board cuts (known as “sequestration”) until March. It does not address raising the debt ceiling, nor the fact that Congress has yet to finalize a budget for the 2013 fiscal year, which began in October.
This partial solution, while better than nothing, is not yet enough to provide businesses and consumers the clarity they need to move forward. Moreover, the protracted standoff demonstrates—once again—lawmakers’ inability to address the United States’ deep fiscal problems. It is unclear at this point whether the partial deal will be enough to keep the major credit ratings agencies, including Standard & Poor’s (S&P), Fitch Ratings and Moody’s Investors Service, from reviewing the U.S. credit rating for possible downgrade.
Implications for economic growth
Overall, we expect this patchwork deal to exert some degree of fiscal drag in the first half of the year, followed by improvement in the second half. This could result in 2013 GDP growth of between 1.5% and 1.8%, similar to the pace in 2012.
The immediate impact will come from reversal of the payroll tax cut, as the level reverts to 6.2% from the 2012 level of 4.2%. This measure begins immediately and can be expected to amount to an economic hit of $125 billion, or 0.8% of GDP, in 2013.
Allowing the Bush tax cuts to expire for individuals with annual income of more than $400,000 and couples with income of more than $450,000 may pull $100 billion from the economy this year, or 0.6% of GDP. This will not be an immediate hit, but likely will be drained from consumption throughout the year. Additionally, it is possible that the Internal Revenue Service will be slow to process tax returns due to the last-minute decision on tax policy. This could cause consumer spending from refund checks to be delayed, theoretically depressing consumer spending in the second quarter and pushing it into the third quarter.
Next round of deadlines
Global markets cheered the deal, with the Dow Jones Industrial Average gaining more than 300 points the following day. However, we believe the celebration will fade quickly as the next round of deadlines approach.
First up is likely to be a debate over raising the U.S. debt ceiling. The federal government reached its borrowing limit on December 31, 2012, but can continue running on temporary measures into February. Failure to raise the debt ceiling would cause the U.S. to default on its debt for the first time in history. This card is in the hands of congressional Republicans, which likely will mean another round of high-stakes brinkmanship within the next two months.
Automatic government spending cuts, designed to hit both domestic and military programs as incentive for both Democrats and Republicans to compromise, have been postponed until March. The sequestration calls for $1.2 trillion in spending cuts over the next decade, with $110 billion scheduled to occur in 2013. The postponement helps us avoid a recession in the first half of 2013; unfortunately the new deadline will coincide with the debt ceiling debate. While the sequestration (originally accounting for $110 billion per year over 10 years or 0.7% of current GDP), would not siphon from growth immediately, it will need to be addressed.
Finally, Congress will need to approve this year’s budget, as the continuing resolution that has kept the government running since October will expire on March 27. The White House is due to unveil its fiscal 2014 plans in February, but Congress has not yet approved the fiscal 2013 budget.
It is imperative that Congress smoothly address the delayed sequestration and debt ceiling issues, then tackle tax reform, to provide the much-needed clarity needed for businesses to plan for the future.
Slow path to progress
Given the political posturing that has characterized the fiscal process over the past two-plus years, businesses and consumers may be expected to have little, if any, confidence in lawmakers’ ability to accomplish much over the next two months.
However, we do believe that Washington will continue to inch forward, albeit painfully slowly, toward resolution of the remaining issues. That would set the U.S. economy up for accelerating growth in the second half and a possible return to potential (above 2%) growth rates in 2014.
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The views expressed are those of the Janus fixed income team. They do not necessarily reflect the views of Janus portfolio managers or other persons in Janus’ organization. These views are subject to change at any time based on market and other conditions, and Janus disclaims any responsibility to update such views. No forecasts can be guaranteed. These views may not be relied upon as investment advice or as an indication of trading intent on behalf of any Janus fund.
In preparing this document, Janus has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources.
Statements in this piece that reflect projections or expectations of future financial or economic performance of the markets in general are forward-looking statements. Actual results or events may differ materially from those projected, estimated, assumed or anticipated in any such forward-looking statements. Important factors that could result in such differences, in addition to the other factors noted with such forward-looking statements, include general economic conditions such as inflation, recession and interest rates.
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