The Sequester and Beyond

February was generally a good month for the markets, with most U.S. markets adding to their existing gains so far in 2013. Bond markets ticked upward and erased a substantial portion of the small losses incurred in January. The Dow Jones finally reached the 14,000 mark once again and flirted with all-time high levels that were reached prior to the ‘Great Recession.’

Despite these positives, the more concerning news item is the lack of a deal to avoid the automatic spending cuts brought on by reaching the extended ‘fiscal cliff’ deadline. Passing the deadline without a deal means the implementation of the ‘sequester cuts’ that reduce spending for national defense, Medicare, and other Federal budget items. Though the overall amount of the cuts of $85 billion is small relative to the $3.55 trillion Federal budget, the continued partisanship and unwillingness to negotiate is the more problematic issue. Another deadline is looming at the end of March, when lawmakers have until March 27 to reach a deal to authorize funding to keep the government funded and running for the rest of the year.

The good news is that the markets have generally shrugged off this missed deadline. Market momentum has continued upward and the Dow reached a new all-time high in early March. Some economists feel that the economy and markets will strengthen further once we have passed all of the self-made deadlines in Washington on the various budget and fiscal policy issues that are currently up for debate. The sequester cuts may have a slowing effect on the already fragile economic recovery, but there are expectations for some strengthening in the second half of the year. Passing each of these deadlines in Washington removes some uncertainty from the markets, and that typically leads to good market performance.

That does not necessarily mean that we are in the clear when we finally pass all of these deadlines, as persistently high unemployment remains a concern and corporate earnings continue to be mixed. The Federal Reserve has already sparked some concern that their latest stimulus program might not last as long as previously anticipated, which could be problematic if inflation increases before a there is a substantial decline in unemployment.

Despite these concerns, if Congress and the President can reach a deal prior to the next fiscal deadline, the certainty provided by a deal could provide some momentum that bolsters market returns and hopefully leads to a strengthening economic recovery as we move through the rest of 2013.

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