When lawmakers reached a compromise in early January to avoid sending the country over the fiscal cliff, they also delayed sequestration, a series of automatic spending cuts, until March 1. As of press time, policymakers indicate that a deal is unlikely to be struck before the deadline this Friday, and the immediate economic impact is projected to be severe.
The first round of sequestration would involve $85 billion in federal spending cuts, affecting the operation of national parks, defense expenditures, and the jobs of FBI agents, firefighters, federal prosecutors, government researchers and air traffic controllers, among others. Sequestration would actually cut 2013 spending by about $44 billion, according to the Congressional Budget Office, while the remaining cuts would be introduced over time.
These initial cuts could result in an estimated loss in gross domestic product (GDP) of 0.5 percentage points in 2013, the New York Times reports. Other estimates put the cumulative loss stemming from the sequester and the tax deal as high as 1.25 percentage points.
J.P. Morgan has also adjusted its estimate of U.S. GDP growth down to 1.9 percent from 2.1 percent based on more palpable fears that sequestration will trigger, MarketWatch notes.
Additionally, the drop in GDP will coincide with lower consumer spending and rising gasoline prices. Wal-Mart noted that its sales ticked down slightly before the fiscal cliff deal and the company expects flat sales for February through April. Defense contractors expect fewer government orders if Congress doesn’t avoid sequestration, but most anticipate a deal by March 1.
Congress is back in session today following a nine-day recess, but top Congressional leaders have been working with the White House to develop a deal for some time now. Both sides are publicly blaming the other for using the budget to score political wins, which critics describe as irresponsible due to the magnitude of sequestration effects.
“It’s the nature of the cuts that is most pernicious – across-the-board, without thought, cutting everything and anything including programs everyone thinks are good and effective,” Moody’s Analytics chief economist Mark Zandi told the Times. “It’s impossible to calculate in terms of dollars and cents what you’re doing when you have these mindless cuts.”
Leading Economic Indicators Improve
The index of U.S. leading economic indicators inched up in January at a slightly slower pace, marking the second consecutive month of growth and suggesting that the economy will sustain its steady expansion through the first half of the year. The Conference Board’s Leading Economic Index (LEI) for the U.S. rose 0.2 percent in January to 94.1, following a 0.5 percent increase in December, and no change in November.
January’s reading came in just below expectations, as economists polled by MarketWatch had forecast the LEI to rise by 0.3 percent for the month. However, the long-term trend remains positive. In the six months leading up to January, the LEI increased a total of 1.1 percent, up from a 1 percent gain in the prior six-month period.
“The indicators point to an underlying economy that remains relatively sound but sluggish. Credit use has picked up, driven in part by relatively strong demand for auto loans,” Ken Goldstein, economist for the Conference Board, noted. “The biggest positive factor is housing. The housing market is now at twice the level reached during its recessionary lows, and will likely continue to improve through the spring, delivering some growth momentum to the labor market and the overall economy. The biggest risk, however, is the adverse impact of cuts in federal spending.”
The LEI is a weighted gauge of 10 indicators tracking business cycle peaks and troughs. Six of the 10 indicators improved in January, led by the interest-rate spread, rising stock prices, the leading credit index, jobless claims, building permits, and manufacturers’ new orders for consumer goods and materials.
“Consumers may trim their spending as the effects of a smaller paycheck set in. Congress and President Barack Obama allowed the payroll tax to return to its 2010 level of 6.2 percent from 4.2 percent at the start of the year. An American who earns $50,000 is taking home about $83 less a month because of the levy,” Bloomberg News reports. “Additionally, economists are projecting Congress likely won’t find a resolution to prevent automatic spending cuts scheduled to begin March 1, which could further dampen economic growth.”
U.S. Factory Sector Continues Growth
Research firm Markit’s latest Purchasing Managers Index (PMI) found that manufacturing and services in the U.S. continued to grow through February, albeit at a slower rate. The PMI fell to 55.2 this month, down from a nine-month peak of 55.8 in January. Readings above 50 indicate overall expansion.
“U.S. manufacturers reported the largest monthly rise in production for almost two years in February, suggesting that the economy is set to rebound from the weak patch seen late last year and allaying fears of a double-dip recession,” Chris Williamson, chief economist at Markit, explained. “The domestic market is providing the main stimulus to growth, but weak demand in other countries caused export orders to fall slightly for the first time since October.”
Manufacturing production climbed to 58.1 in February, up from 56.8 in January and outpacing the series’ average. Domestic demand drove new orders to 56.4, slightly slower growth than January’s 57.4 reading, while the employment index totaled 54.1, down from 55.6 the prior month, as companies continued to add new staff to meet rising output requirements, but at a more sluggish pace.
Meanwhile, export orders dropped to 48.7 this month, down from 51.5 in January and indicating the first contraction in four months, though the rate of decline was “only modest.”
“While the survey therefore paints an encouraging picture of the manufacturing sector, helping to drive a return to growth for the economy as a whole in the first quarter of this year, firms still need to see greater confidence in the longer-term economic outlook for employment numbers to pick up again,” Williamson added.
Metalforming Industry to See Stronger Business Activity
Metalforming companies are expecting a rise in economic activity over the next three months, although the industry has seen a slight increase in worker layoffs recently.
The latest business conditions report from the Precision Metalforming Association reveals that 37 percent of metalforming firms predict business will improve in the short-term, up from 32 percent in January. Fifty-five percent of metalforming companies expect activity to remain unchanged, compared to 50 percent in January, while 8 percent predict activity will drop, compared to 18 percent last month. The gain is reflected in a rapid rise in shipping levels, which rose from 21 percent in January to 44 percent in February.
Half the respondents predict an increase in orders, up from 44 percent in January. Thirty-nine percent anticipate no change, and 11 percent expect a decrease in orders.
Despite the positive signs, industry layoffs have increased. While 15 percent of metalforming companies reported that a portion of their workforce was moved to shorter hours or laid off in January, the number rose to 19 percent in February, up considerably from the 7 percent rate a year ago.
“Growth is expected to be modest but should continue throughout the spring unless a lack of leadership in Washington, D.C., leads to an economic shock resulting from sequestration or other issues,” PMA President William E. Gaskin said.
Jobless Claims Surge
New initial jobless claims rose sharply in the latest week reported, returning to levels seen prior to the holiday season and indicating mounting weakness in the national job market. According to the U.S. Department of Labor, unemployment claims for the week ending February 16 increased by 20,000, to a total of 362,000.
Meanwhile, the four-week moving average, which smoothes out volatility and provides a clearer long-term picture of labor market conditions, rose by 8,000 to 360,750. Claims may have been disproportionately lower in recent weeks due to snowstorms and other inclement weather.
“Overall, average claims are down from where they were a year ago, but the improvement has been very gradual. They’ve largely been hovering in the 350,000 to 400,000 range – a level that seems to be consistent with the U.S. economy, which has added about 180,000 jobs each month,” CNN Money reports. “But that’s barely enough to keep up with population growth and not enough to make significant improvement in reducing the unemployment rate.”