Sequestration a faux crisis

You would think the media had learned its lesson from the non-event that was the fiscal cliff. But anxiety equals ratings in the television game, so ‘sequestration’ is on everyone’s mind these days.

It means $85 billion in automatic spending cuts for this fiscal year and $1.2 trillion over the next ten years. While sequestration officially hit on March 1, the failure of Congress to agree on a budget will not be fully realized until May or June.

The cuts are split 50%-50% between defense and domestic discretionary spending, and it is designed to help get a handle on the growth of the U.S. national debt, now at more than $16 trillion. The sequester has been coming for more than a year, with Congress pushing it back to March 1 as part of the fiscal cliff deal at the end of the last session.

Read: Sequestration to hit U.S. economy

In preparation for likely budget cuts, some federal agencies have gone so far as to notify their employees to prepare for taking one day off per week without pay – a 20% reduction in pay. Beyond federal workers, there may be adverse consequences for those who work on projects contracted out by the federal government.

Congress has been unable to reach a budget deal by the deadline and following the fiscal cliff debacle, it was hoped a deal would be hammered out. It appears the ideological divide between Republicans and Democrats continues to grow, casting a shadow on the government’s ability to meet deadlines.

Notwithstanding the partisanship, passing a budget in the days or weeks ahead can still avert much of the spending cut damage. Congress can put in place a bill that would limit much of the impact of the spending cuts and help government agencies achieve savings by making their operations more efficient.

The sequester deadline has served as the latest distraction for investors, and much of the hype has already been priced into bonds, currencies, and stocks. However, looking forward, there are other, more important dates on the fiscal agenda to keep an eye on. The last new federal budget was passed in 2009, and the government has been agreeing each year to spend in the same fashion as the year before.

If they do not agree to either a short-term extension or passage of an actual budget by March 27th, the government will shut down. Congress is likely to agree on a band-aid extension to April 15, as both Congress and the Senate are due to submit their budgets on that date.

Read: Cliff averted, but confrontation looms

If either the Senate or the House doesn’t pass their respective budget resolutions by then, the members of that body would not be paid until they pass it or on the last day of the Congress, in January 2014. Finally, May 19 is the date when the U.S. will once again hit its debt ceiling.

Trading week ahead

Did you know the S&P 500 Index has returned 24% on average in years where both January and February returns were positive? The index has climbed in both January and February 26 times since 1945, and all 26 of those years ended with positive returns when dividends are included. So let March madness begin.

Past the sequestration deadline, markets will be held hostage to this week’s political developments. The key economic data release is Friday’s employment report. The consensus February nonfarm payroll forecast is +160 thousand, up only slightly from last month’s +157 thousand. Most labor market indicators (jobless claims, ISM employment gauges, ADP) are pointing to solid but unspectacular job gains. Ahead of Friday’s payrolls is Tuesday’s release of a report on the services sector.

The ISM non-manufacturing index may have eased to its lowest level in three months (55.0), but would still be consistent with solid expansion in the broader U.S. economy. The Fed’s Beige Book (Wednesday) will likely describe modest job growth, subdued wage gains, and continued recovery in the housing sector. The uncertainty created by impending sequestration may appear as a theme in this report. In Canada, the weak domestic economy will keep the Bank of Canada on the sidelines during Wednesday’s policy meeting.

Earnings season in both Canada and the U.S. have concluded but Bank of Nova Scotia is the last of the Canadian banks to report its first quarter results. BNS is expected to report $1.25 of EPS on a record $5.04 billion of revenue. The other banks Canadian banks have raised their dividends this quarter, and BNS is expected to bump its payout by $0.02 to $0.59 each quarter.

Read: TD’s Q1 earnings beat estimates

David Andrews is the Director, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @David_RGMP