By Steven C. Johnson and Jason Lange
NEW YORK/WASHINGTON, March 1 Broad spending cuts
designed to hit most U.S. government programs with all the
subtlety of a sledgehammer were set to begin taking effect on
Friday, yet investors barely batted an eyelash.
The $85 billion in across-the-board "sequestration" cuts
were expected to eventually cause airport delays, disrupt public
services and result in lower pay or layoffs for millions of
What they were not likely to do, at least as far as
financial markets were concerned, was cause enough damage to
derail a U.S. economy that has lately been gaining momentum.
Some also saw the chance of weaker growth and higher
unemployment from the spending cuts making it likelier the
Federal Reserve will keep monetary policy ultra-loose longer.
And the so-called sequester might not even stick around long
enough to have much of an impact, some analysts said.
"The stock market isn't worried. It's at five-year highs,
and the sequester gives the Fed all the more reason to keep its
foot on the gas," said Marc Chandler, global head of currency
strategy at Brown Brothers Harriman.
President Barack Obama and congressional leaders met in the
White House on Friday but did not reach a budget deal. Investors
have had a long time to weigh how the sequester could affect
growth and most believe it will not trigger a recession.
"Most of us believe that sequestration is not something that
will make us fall off the cliff, since the cuts will be worked
in relatively slowly," said Bill Stone, chief investment
strategist at PNC Wealth Management in Philadelphia, which has
$115 billion in assets.
Despite uncertainty around the cuts, "even if the estimates
are right and GDP drops by half a percent, that's not a fatal
blow," he said.
European stocks slid on worries about a slowdown in the
Chinese economy, but encouraging figures on the U.S.
manufacturing sector boosted equities on Wall Street.
The MSCI world stocks index fell 0.23
percent on Friday. The U.S. dollar rose 0.4 percent against a
basket of currencies to a six-month high.
However, the specter of spending cuts in the United States,
the world's biggest oil consumer, worried oil markets. U.S.
crude oil futures fell by $1.37 on Friday to settle at
$90.68 a barrel, the lowest closing price since early December.
U.S. stocks rose, ending the week higher, as data showed
U.S. manufacturing growth rose to its fastest pace in 20 months
The benchmark Dow Jones industrial average is less
than 1.0 percent below a record high, up more than 7.0 percent
this year. The more widely followed Standard & Poor's 500
is less than 4.0 percent from entering record territory.
Even an index of stocks in a sector seen at the cross-hairs
of the spending cuts, the Philadelphia Stock Exchange Defense
Index, hit an all-time intraday high on Thursday and
traded near flat on Friday. The sequester will hit the U.S.
military particularly hard, with defense programs set to be cut
about 13 percent. Yet the index has gained nearly 7.0 percent
Investors said continued support from the Fed, after
Chairman Ben Bernanke mounted a strong defense of the central
bank's stimulus policy this week, would blunt the cuts' effects.
What's more, markets have been down this road before. In
late 2012, investors and CEOs fretted that the sequester,
initially to take effect in January along with $500 billion of
tax increases, would cause a new recession.
A deal struck by Republicans and Democrats on New Year's Day
averted most of the tax hikes but postponed the spending cuts
until March 1. Major U.S. stock indexes rallied anyway, with the
S&P 500 up 6.0 percent and the Dow up 7.0 percent this year.
Economists are not as relaxed. Many say government belt
tightening will put a brake on growth this year, whether or not
the sequester happens.
The Congressional Budget Office, whose calculations are the
foundation of many Wall Street forecasts, says fiscal tightening
will knock about 1.5 percentage points from growth this year.
The spending cuts from the sequester make up a third of
that, or 0.6 percentage points. A tax hike enacted in January
will also drag on the economy, as will other spending cuts.
The labor market would also suffer, ending 2013 with 750,000
fewer jobs than without the sequester, the CBO estimates.
These worries have pushed some investors into the relative
safety of U.S. government bonds, with the benchmark 10-year
yield slipping to 1.84 percent this week after
hitting 2.06 percent, its high for the year, on Feb. 14.
Bernanke, speaking to lawmakers on Wednesday, urged Congress
to try to push spending cuts further into the future to shield a
"If you slow the economy that hurts your revenues. And that
means your deficit reduction is not as big as you think it is,"
Many investors, though, say the cuts, while annoying and
painful, are too small a percentage of federal spending to do
serious damage to the economy or have much impact on the
deficit, which has exceeded $1 trillion for four years.
STILL TIME ON THE CLOCK
The question appears to be the duration of the budget cuts.
Standard & Poor's expects the sequester to be replaced in
the second quarter by a long-term package of spending cuts and
"If this proves true, we think the sequester would still
have only a mild downside effect on GDP growth this year," the
rating agency said in a statement.
If the cuts last only a few weeks, the impact on growth and
jobs could be marginal because some budget cuts will not
translate into immediate spending cuts.
The Defense Department, for example, will probably not begin
furloughing some 800,000 civilian workers until late April,
after which these workers will work one day less per week.
Budget cuts for capital spending could also be delayed.
The CBO estimates that only about half of the $85 billion in
budget cuts planned from March through September would translate
into lower spending during that period.
Once the furloughs and other spending cuts take hold,
though, workers will feel the pinch, especially the 2.8 million
people employed by the federal government.
"Their income is going to shrink considerably," said Omair
Sharif, an economist at RBS in Stamford, Connecticut.
Tim Ghriskey, chief investment officer at Solaris Asset
Management, said he thinks markets are betting all this will
force Republicans and Democrats to the bargaining table.
"The grace period is probably a month or two," Ghriskey
said. "But if it becomes clear that these arbitrary cuts are
starting to do damage and there's no sign of compromise, that's
when the market could start to react."