Good Economic News Overshadows Sequestration’s Fearful Impact
Oceanside, CA – For much of the past few months, sequestration has been evoking concern and fear. After it became effective on March 1, the impact so far has been more of a whimper even despite all the political grandstanding about its probable detrimental effects on the economy. Though its full impact will not be known for a few months, so far the markets have responded with record highs for the Dow Jones and near record highs for the S&P 500. Also, Gallup's Economic Confidence Index has remained positive during March. However, trade shows involved in the government sector can expect less participation as many of the early announcements from federal agencies involved cutbacks in travel, training and conferences.
“Sequestration will tighten the budgets of more than 20 federal agencies, the White House and Congress over the next seven months to the tune of $85 billion for this year, “ said Frank Chow, chief economist to Trade Show Executive. He noted the reductions are split between defense spending, which will bear the brunt for half of the cuts, and domestic programs. Medicare payments to doctors and hospitals will also be trimmed. “These cuts amount to only 2.4% of annual federal spending, but they are being leveled in such an indiscriminate way that the President’s administration has warned they could prove disruptive in such areas as air travel, immigration, housing, education and transportation,” Chow emphasized. The Department of Commerce and Department of Defense have already announced reductions in training and conferences, he pointed out.
“The muted response to sequestration has certainly been a surprise especially in combination with the higher payroll taxes that started in January,” Chow said. “Most analysts certainly expected a drop in consumer spending — that did not happen.” In February, U.S. retail sales grew by 1.1%, the biggest boost in five months, after a 0.2% gain in January, and double the consensus forecast. The spending was led by gasoline and auto sales. Excluding autos and gas, retail sales still rose 0.4%, also double what was expected. Additionally, the Commerce Department reported U.S. business inventories in January grew 1%, the most since May 2011. Obviously, neither employers nor consumers were scared off by the months of dire predictions out of Washington, DC.
Should we expect such spending to continue? Chow said the answer lies in the reasons for the encouraging reaction from consumers and businesses. Some economists believe the unexpected spending is being fueled by the Federal Reserve’s accommodative monetary policy. Numerous quantitative easing measures have pumped up stock prices and contributed to higher home prices by keeping mortgage rates at record lows. This has led to rising household net worth of which the largest components are stocks and homes. The Federal Reserve’s Flow of Funds Accounts for 2012 indicate net worth climbed for most of the year and was nearing its 2007 record peak by the end of 2012. “By the end of the First Quarter of 2013, net worth may hit an all-time high because both stock and housing prices have escalated significantly,” Chow indicated. Businesses are encouraged by the improving employment picture and the stronger-than-expected Fourth Quarter earnings. “The inventory increase usually implies companies expect future demand to pick up soon,” he pointed out.
Some economists have upped their 2013 GDP forecasts recently based on the continued strength of consumer spending. However, Chow expects the economy will be mired in very slow growth for the near future until the structural issues facing the U.S. [noted in previous Trending & Spending columns] get resolved. “It’s going to be touch-and-go for the consumer for the next few months,” said Ryan Sweet, senior economist at Moody’s Analytics. “The consumer is going to be able to support the recovery, but they’re not going to be able to take it” to a higher level, he said.
Chow also said, with conviction, that much of the recent good economic news has simply overwhelmed sequestration’s fearful impact. The First Quarter looks to be better than originally expected:
- The economy added 236,000 jobs in February, bringing the unemployment rate down to 7.7% from 7.9% in January. The job gains were broad-based, led by 48,000 for construction — the most in six years. Also, retailers added 24,000 jobs, while education and health services added 24,000.
- About 64% of corporations reported Fourth Quarter 2012 revenue above analysts’ expectations and 69% exceeded earnings expectations, according to Thomson Reuters.
- New home sales jumped 16% in January — the highest level since July 2008 and existing home sales rose 0.8% in February to the highest level since November 2009 with the median sales price 11.6% higher than last February.
- Hourly wages rose 4 cents to $23.82 in February. Wages have risen 2.1% in the past year, slightly ahead of inflation.
- Besides the solid overall retail sales numbers, auto sales were up 14% in January and 3.7% in February, driven largely by the revival in home prices and construction, according to GM and Ford executives.
- Gasoline and energy prices started to fall in March, bringing costs relief to industry, businesses and consumers.
Does this mean the recovery is gearing up to rise to another level? “I think probably not,” said Chow. “There are still 12 million unemployed and even millions more with unwanted part-time jobs or have left the labor force.” Meanwhile, the automatic government spending cuts which took effect March 1 will likely take time to ripple into the broader economy, he believes. Consumer confidence, as measured by the preliminary Thomson Reuters/University of Michigan Sentiment Index unexpectedly slumped in March, which may signal a cooling in spending. “This may be related to the sequester,” Chow said, “but on the other hand, a recent Fox News poll found 73% of voters think cutting government spending is more likely to strengthen the economy than increasing spending will.” He said a lot of uncertainty still remains regarding the nation’s fiscal health as politicians continue to wrangle over the budget deficit and the burgeoning federal debt, which is now over $16 trillion. “This uncertainty will curb spending growth and business investment,” Chow noted.
Another big issue facing the economy later this year, and for companies in particular, is the Affordable Care Act (Obamacare), which is set to be fully implemented in 2014. Businesses are still confused due to the numerous rule changes, waivers, clarifications, litigation, and the sheer complexity of it. Premiums are forecasted to skyrocket as insurance companies grapple with the 41 essential health benefits mandated for coverage under Obamacare according to eHealth Inc. Companies are unsure how much this will impact their costs, but must make staffing decisions later in the year to prepare for the huge change.
Some analysts predict many employers will pay the opt-out penalty and let the state exchanges provide the insurance coverage for their employees; such action is estimated to save companies about $8,000 per employee. Others say employers will not save anything because workers will expect to be compensated by higher wages if employers opt-out. Or it could be something in the middle and negotiated between employer and employee. No one really knows — thus the uncertainty. Just over half — 26 states — have decided to let the Federal government run their exchange. The other states will partner with the Feds and form their own exchanges. Based on the historical performances of most federal programs, I suspect the Fed’s expense to run these exchanges will far exceed their budgets and drive up the federal deficit and debt even more. Open enrollment in the state exchanges is scheduled to open October 1, 2013. We will report further when more information becomes available.
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