With the New Year, we can put away all the holiday trimmings and clean up after the succession of bowl games.
We can also put behind a couple of potentially economically altering events.
These include leadership elections in both the U.S. and China, the two largest economies, statements by the European Central Bank to do whatever it takes to preserve the euro, resolution of part one of the so-called “fiscal cliff” and continuing accommodation by the Federal Reserve.
Congress and the White House came to an agreement on the fiscal revenue side of the “fiscal cliff.” The media has addressed the various tax bracket increases, phase out of exemptions and deductions and change in capital gains rates for some tax payers. Mostly these will affect higher income tax payers. The sunset of the payroll tax holiday is affecting all taxpayers receiving a pay check. It has been estimated that the additional revenue will create a budget restraint of around 1.4 percent of nominal gross domestic product. This, of course, depends upon your base case assumption. The new tax law reduced revenues from what they would have been had no compromise been reached. The remaining portions of the “fiscal cliff” were acted on, sort of. The expense side or sequestration was pushed out two months.
Approximately $110 billion in spending reductions were to begin starting January 1. The action taken postpones implementation and opens for debate all of the planned spending reductions totaling $1.2 trillion over 10 years. This debate may make that of December look tame indeed. Add in the need to address the federal debt ceiling of $16.4 trillion, reached at year end, but operating by means of extraordinary measures. Without a meaningful change in the deficit trajectory over the next few months, one or more of the bond rating agencies have hinted of a possible downgrade of U.S. debt. Last but not least is that a series of continuing budget resolutions to operate the federal government are set to expire at the end of March.
Typically a debt rating downgrade would entail higher interest rates. But the Federal Reserve has commenced purchasing $45 billion per month of Treasuries along with an additional $40 billion per month of mortgage backed securities. The Fed has committed to keep federal funds rate low as long as the unemployment rate is above 6.5 percent (currently 7.8 percent) and inflation between 1-2 years is projected to be no more than 2.5 percent. For all of 2012 consumer prices climbed 1.7 percent while core consumer prices, excluding food and energy, climbed 1.9 percent. The 10-year inflation expectation stands at a current 2.5 percent. The minutes from recent meetings of the Federal Reserve suggest that some members believe these asset purchases could slow or halt entirely before the end of 2013. But this is based on assumptions by the majority of Fed members that economic growth will strengthen. Whether this happens or not, this year could prove to be an inflection point for interest rates.
Every New Year brings a wave of economic predictions. This year these are heavily footnoted with assumptions on what politicians will do, what the Fed might do and what impact either will have on the U.S. consumer. There are other predictive indicators that are used, including the gain of equity markets in the first 5 trading days of January or the entire month of January predicting stock market direction for the year; the outcome of the Super Bowl to predict a gain or loss on stock market indices for the year; or a host of other “indicators.” The net results of the past several months have produced some resolution and reduced some uncertainty. We still have issues to resolve that could generate some volatility for the markets.
David Helscher is a senior vice president and trust officer with Clinton National Bank.