The latest of terrifying political crises to torment Wall Street is the Sequester, which according to experts, threatens the economy. However, like the villagers who heard the boy who cried wolf, the stock market just won’t buy it this time. The SPDR S&P 500 (NYSE: SPY), which mimics the performance of the index by the same name, is unchanged so far this week, a period in which all was supposed to fall apart. So who is right about this issue, the stock market or the media, and will the Sequester cause a recession or just a bout of indigestion?
According to Federal Reserve Bank Chairman Benjamin Bernanke, who addressed the financial committees of both the House and Senate this week, the Sequester will set into action a course of cuts that will create a drag against economic growth at a time when the economy remains vulnerable. He said the Sequester would impact real GDP by 0.6%, and it was part of a series of measures costing the economy 1.5 percentage points of growth this year. Bernanke clearly opposes the sequester, and recommended that Congress consider replacing sequestration with policies that reduce spending less in the near-term but more substantially over the long-term. He even suggested that sequestration would actually hamper deficit reduction, because more could be accomplished with the greater tax revenues earned by a healthier economy excluding such measures.
The Sequester is a series of self-inflicted injuries set to take effect on March 1st, with some $85 billion in undesirable spending cuts planned. Devised back in 2011, the Sequester was designed to be so unappealing to both Democrats and Republicans as to force the quarrelling political parties to find common ground and a better bipartisan solution. Yet, as the cut-off date approaches, it appears there may not be a midnight hour solution like those we have grown accustomed to with the fiscal cliff and debt ceiling issues.
The Federal Reserve forecasts Real GDP growth of 2.3% to 3.0% for 2013 and 3.0% to 3.5% for 2014. So if the sequester was not expected or accounted for within the forecasts last updated in December 2012, then the 0.6% impact would bring estimates down to 1.7% to 2.4% Real GDP growth. That means the Sequester should not cause a recession.
However, the seriousness of the sequester issue cannot be overstated. First of all, half of the planned cuts are targeted for the Pentagon and Homeland Security, areas where politicians tend to do their best to keep their hands clean. Homeland Security Secretary Janet Napolitano said the sequester cuts would be disruptive and destructive to our nation’s security and economy, which must terrify politicians to hear. The President said the nation cannot continue to careen from one manufactured crisis to another. This political ploy put into effect to give impetus to budget management, has instead placed a spotlight on the political problems that continue to plague our nation. So, while we should not enter into a recession because of the Sequester cuts, we have plenty to worry about.