Sequester: The Next Economic Guessing Game

Washington always seems to be generating something for economists to worry about. The latest concern: About $110 billion in annual government spending cuts due to start at the beginning of March.

The so-called sequester dates to the summer of 2011 and the last-minute deal back then to raise the government's borrowing limit. That deal called for spending cuts to begin at the start of 2013, but Congress delayed that by two months as part of the fiscal-cliff compromise. So now, unless there are further delays, Washington is about to finally take a small step toward curtailing deficit spending.

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Forecasters are split on whether Washington politicians will really allow across-the-board spending cuts--which are supposed to hit most agencies but exempt entitlement programs such as Social Security and Medicare--to kick in. Most analysts agree that it's a clumsy way to cut spending, because it makes no effort to prioritize important programs over expendable ones. But that doesn't mean it won't happen.

Bank of America Merrill Lynch predicts that despite efforts to come up with workarounds, the full sequester will go into effect. Under that scenario, there would be the usual headline-grabbing chatter about different types of compromises to prevent the cuts from happening, all of it accomplishing nothing.

But others think Congress will come up with some kind of last-minute plan to avert the cuts, as it has on other issues. Paul Sheard, global chief economist for Standard & Poor's, said at a recent conference sponsored by New York University's Stern School of Business that he expects no more than half of the sequester to go into effect. The differing views reflect the difficulty of predicting political outcomes in Washington.

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There's more agreement on how the spending cuts will affect the economy if they do go into effect. Forecasting firm Macroeconomic Advisers estimates that $110 billion in spending cuts would reduce GPD growth by about 0.7 percentage points in 2013 and 2014. That's not enough to cause a recession, but it will significantly slow job creation and other factors that make the difference between a stagnant economy and one that's growing modestly.

That matters a lot for the direction of the stock market, which is becoming a matter of bipolar opinion. Stocks have been quite buoyant recently, with the S&P 500 stock index up more than six percent so far this year. That suggests investors are increasingly upbeat on growth, profits, and the long-term outlook--and hoping to cash in on gains.

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But others think the market is headed for a correction in coming weeks because investors have become complacent and too blithe about Washington politicians coming up with last-minute solutions to every problem. "There is a considerable, and unappreciated, risk right now that a kumbaya agreement won't be struck on the sequestration," Patrick O'Hare of Briefing.com wrote in a recent analysis. "The stock market is absolutely not priced for that potential disappointment."

So once again, the outlook for jobs, investments and elusive prosperity may hinge on a Washington policy impasse. "Sequester" could soon become one of those unhappy buzzwords that means we'll just have to wait a bit longer to see if Washington torpedoes the economy.

Rick Newman's latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.



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