MacroScope

The real sequester threat: rising political risk in the United States

Despite the Obama administration’s cataclysmic warnings about the effects of $85 billion in looming spending cuts known as the “sequester,” chances are the lights will not go out when they kick in this weekend. Still, the economic impact could be significant. The cutbacks might shave a half percentage point or more from an economy that is forecast to grow around 2 percent this year — but which only mustered a 0.1 percent increase in annualized fourth quarter GDP. This, at a time when a similar austerity-driven approach has left much of Europe mired in recession.

Both the public and the markets seem to be taking Washington’s latest war of words in stride. After all, people are becoming inured to the regularly scheduled fiscal crises that have become a part of the capital’s landscape. But the sequester’s most frightening potential consequence is much broader than its near-term economic ripples. The real danger is that, with every new episode of political theater over the budget, America’s credibility as a serious, trustworthy nation is eroded. The concept of political risk, once reserved for banana republics in the developing world, is now very much alive in the United States. And that is one liberty a debtor nation cannot afford to take.

Ignore the noise around Britain’s GDP figures

One of two stories will probably emerge from Friday’s first reading on how the British economy fared at the end of last year.

If it shrank 0.1 percent in the fourth quarter as the consensus of economists polled by Reuters expects, or worse, we will hear it raises the disastrous spectre of a third recession in four years, or a “triple-dip”.

If it defies expectations by growing slightly, that risk is averted and the government will say it shows the economy is getting back on its feet.

On fiscal ledge, corporate gain may be household’s pain

It doesn’t sound sustainable but, at least in coming months, businesses look set to keep booming even as consumers come under pressure – in line with the recent trend. That’s because the economic hit from the partial deal on the fiscal cliff will hurt salaried workers disproportionately, says Steven Ricchiuto, chief economist at Mizuho.

He writes:

Although the worst of the fiscal cliff has been avoided, the compromise is not macroeconomic neutral. Our calculations, in fact, suggest that the drag created by the reversal of the payroll tax cut and the various tax hikes on upper income households will cut real GDP by upwards of 0.5% to 1% from our preliminary 1.5% to 2% forecast.

Real GDP in the range of 0.5% to 1.5% this year implies that corporate profit growth will come at the expense of the wage earner. Moreover, the earnings focus assures a larger share of national income will accrue to the corporate sector. This implies another year of limited employment gains.

Italian political curveball

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Italy’s borrowing costs over ten years drew closer to five percent after a decision by Prime Minister Mario Monti to step down early left the country’s political future unclear, hurting riskier euro zone debt.

Monti said on Saturday he would resign once the 2013 budget was approved, raising questions over who will take the reins of the euro zone’s third largest economy at a time when it remains a focus of the region’s three-year debt crisis.

His announcement, potentially bringing forward an election due early next year, came after former prime minister Silvio Berlusconi’s party withdrew its support for the government — and Berlusconi himself said he would run to become premier for a fifth time.

Geithner’s gauntlet: Social Security is a “separate process” from fiscal cliff talks

Social Security should not be part of the current negotiations over the U.S. budget – that was the message from outgoing Treasury Secretary Timothy Geithner over the weekend. During a veritable tour of Sunday shows aimed at addressing negotiations surrounding the “fiscal cliff” of expiring tax cuts and spending reductions, Geithner told ABC News’ “This Week”:

What the president is willing to do is to work with Democrats and Republicans to strengthen Social Security for future generations so Americans can approach retirement with dignity and with the confidence they can retire with a modest guaranteed benefit.

But we think you have to do that in a separate process so that our seniors aren’t – don’t face the concern that we’re somehow going to find savings in Social Security benefits to help reduce the other deficit.

Could renewed U.S. economic strength turn the fiscal cliff into a fiscal ramp?

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The term ‘fiscal cliff’ has now safely transitioned from economic jargon to popular cliché. But how worried should Americans be about the growth-stunting mélange of expiring tax cuts and spending reductions set to begin kicking in at the start of next year?

Economists widely believe that if Congress fails to come to some sort of agreement on the budget, the U.S. economy would plunge into a deep recession. RBS economist Michelle Girard, however, thinks a recent pick up in U.S. economic activity could offset some of the cliff-related weakness.

While uncertainty over the fiscal cliff dominates most conversations, the relative strength of the underlying U.S. economy should not be forgotten. The expansion is today on firmer footing today than at any point in the past three to four years. No major economic imbalance exists. Moreover, headwinds that have hindered the pace of recovery are fading.

Spanish rescue could cause collateral damage for Italy

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Mounting speculation that Spain is prepping for a bailout begs the question – what happens to Italy?

Sources told Reuters Spain is considering freezing pensions and speeding up a planned rise in the retirement age as it races to cut spending and meet conditions of an expected international sovereign aid package.

Markets took this to mean it was preparing the ground for eventually asking for help. According to Lyn Graham-Taylor, fixed income strategist at Rabobank:

Lucky enough to pay taxes

“People. People who pay taxes, Are the luckiest people in the world …” That may not be exactly how the lyrics, most memorably sung by Barbra Streisand in the musical “Funny Girl” actually go, but one could argue that one is lucky to be well off enough to pay federal income taxes.

A research note from Stone & McCarthy Research Associates economist Nancy Vanden Houten wonders why “obsessing about taxpayers with no federal income tax liability” has become a focus of the U.S. presidential campaign.

We think the emphasis is misplaced. A more appropriate question to ask is how much all taxpayers benefit from provisions of the tax code.

Guarded Bernanke still manages to toss a bone to Wall Street and Washington

Ben Bernanke has done it again. In his much-anticipated speech Friday, the Federal Reserve chairman managed to tell both investors and politicians what they wanted to hear – that “the stagnation of the labor market in particular is a grave concern” – all while saying next to nothing new about where U.S. monetary policy is actually headed. That the Fed, as Bernanke also noted, stands ready to ease policy more if needed was well known to anyone paying attention the last few months. We also know that the high jobless rate, at 8.3 percent in July, has long been Bernanke’s main headache in this tepid economic recovery.

Still, in Jackson Hole, Wyoming on Friday, it was like Bernanke tossed a bone to the hounds on Wall Street and in the Beltway without even getting up off his lawn chair.

For markets, hungry as they are for a third round of quantitative easing (QE3), the “grave concern” comment says the high unemployment rate and mostly disappointing job growth since March gives the Fed little if any choice but to act. U.S. stocks climbed and the dollar dropped after the speech, with traders and analysts citing the remark. “‘Grave’ concern with labor market is striking,” said David Ader, head of government bond strategy at CRT Capital Group.

Goldman thinks market’s disappointment with ECB is premature

Financial markets on Thursday were starkly disappointed with the European Central Bank and its president, Mario Draghi. He had promised recently to do everything in his power to save the euro and yet announced no new bond-buying at the central bank’s latest meeting. Riskier assets sold off and safe-haven securities benefitted.

But Francesco Garzarelli of Goldman Sachs, Draghi’s former employer, has a different take on the matter:

We see a material change in the central bank’s approach to the crisis, and a coherent interplay between fiscal and monetary policy. The underwhelming part of today’s announcements lies in the lack of details on the asset purchases and other measures to support the private sector. But it appears that these will have more structure around them than the SMP (Securities Markets Program).