Guest post written by Hillary Elder, Director, Money Market Strategies, HighMark Capital Management
In November 2011, after months of debate, Congress was unable to arrive at an agreement to gradually reduce the U.S. deficit. As a result, they deferred any decision by implementing a process called sequestration, scheduled to take effect in January 2013. This draconian option was thought sufficient to motivate both political parties to focus on resolving their differences. It was never intended to actually take effect, as it will trigger across- the- board spending cuts of $1.2 trillion over 10 years to both domestic and defense programs.
Since that time, there has been no progress on dealing with the nation’s long term budget problems as partisanship and electioneering have prolonged the stalemate. The hope is that following next month’s election lawmakers will refocus to tackle this issue. There is also the expectation that discussions will need to be held as soon as February 2013 regarding once again raising the statutory debt ceiling from the current $14.7 trillion. Last month, before leaving to campaign, Congress passed a six month continuing resolution to fund the U.S. government through March 2013.
There has been some posturing about allowing the economy to go over the fiscal cliff; thereby allowing the Bush tax cuts to sunset and setting the stage to extract revenue concessions. There has also been talk about the political parties negotiating a compromise that effectively amounts to finding a way to kick the can down the road once again. Both would be viewed extremely negatively by the major rating agencies. Three of the Nationally Recognized Statistical Rating Organizations have already weighed in with strong words as to the likely impact on the country’s credit rating should a credible plan not be forthcoming. Recall that in August 2011, after an acrimonious battle over raising the U.S. debt limit, Standard and Poor’s Corporation downgraded the U.S. long-term credit rating from AAA to AA+. To date they have been the only agency to take this action.
At HighMark Capital Management we believe that there will be an agreement reached to delay the sequester, either in the lame duck session immediately following the election or as soon as the next Administration is sworn in. Voters are keenly focused on this issue and are likely to be unforgiving of failure to show progress in this area. Our view is that this will likely entail a one year phase out of the reduction in payroll taxes, extension of the Bush tax cuts for middle income taxpayers and continuation of long term unemployment insurance benefits. Fixes to Medicare reimbursement amounts for physicians, and inflation indexing of the Alternative Minimum Tax (AMT) are also pressing issues that we think will be addressed in the first deal.
On the larger issues, such as the future of Social Security and Medicare, the political parties are deeply divided, making reform very difficult to predict.
Neither party wants to be seen as responsible for precipitating a downgrade of the U.S. debt rating or for pushing the economy into recession once again, so there will likely be cooperation sufficient to reduce the risk of a fiscal crisis, and inject a measure of certainty into tax policy. The hope is that businesses and consumers will then invest and spend to spur economic growth.
The Federal Reserve has held short-term interest rates at or near zero since December 2008, and implemented several rounds of quantitative easing. At the conclusion of their Sept 13th meeting Chairman Bernanke used his statement to stress the Board’s commitment to promoting stronger economic growth, stating that they would likely
keep interest rates low through mid 2015 and would not tighten monetary policy until the unemployment rate falls below 7%. This change in tone implies that the Fed would tolerate a slightly higher rate of inflation to promote job growth.
We do not expect another rating downgrade, but it is important to note that such a development does not preclude a short term fund such as NIFCU$ from investing in or retaining securities issued or guaranteed by the U.S. Treasury, and therefore would not change our strategy. Moreover, our belief is that another one notch downgrade would likely not impact funding costs given the low interest rate environment, and U.S. Government securities continue to be valued as safe, liquid investment alternatives in light of the continuing economic challenges in the Euro-zone.
We will continue to monitor events in the global markets, adjust strategy accordingly, and will keep you updated.
For more information visit: www.nafcu.org/nifcus