NEW YORK (Reuters) - Broad spending cuts designed to slam most U.S. government programs with all the subtlety of a sledgehammer were set to begin taking effect on Friday, yet investors have so far barely batted an eyelash.
The $85 billion in across-the-board "sequestration" cuts were expected to cause airport delays, disrupt public services and result in lower pay or layoffs for millions of government workers.
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.
"There is no immediate and visible impact to the economy so markets are not seeing it as a tail risk," said Ayako Sera, a market economist at Sumitomo Mitsui Trust Bank in Tokyo.
"It's not that money will stop circulating, unlike in the case of a debt ceiling where necessary government payments due will be suspended. So maybe time is needed for markets to digest the significance of the news, prompting investors to stay to the sidelines," she said.
Initial reaction in Asia was muted, with the MSCI's broadest index of Asia-Pacific shares outside Japan <.miapj0000pus> easing 0.1 percent on Friday, while the dollar was down 0.1 percent for much of the session against a basket of currencies. The risk-sensitive Australian dollar rose 0.2 percent to $1.0230, digesting key Chinese manufacturing data.
"The market is looking at this and saying, 'You know what? This is not going to lead to a recession,'" said Quincy Krosby, market strategist at Prudential Financial in Newark. "Will it cause a pull-back in growth? Yes. But we can live with that."
That certainly appears to be the stock market's read. The Dow Jones industrial average <.dji> sits just 1 percent below a record high after a more than 7 percent year-to-date rise. The more widely followed Standard & Poor's 500 <.spx> is less than 4 percent from regaining record territory.
Even an index of stocks in a sector seen at the cross-hairs of the cuts, the Philadelphia Stock Exchange Defense Index <.dfx>, hit an all-time high on Thursday. The sequester will hit the military particularly hard, with defense programs set to be cut about 13 percent. Yet the index is up 7 percent this year.
Investors said continued support from the Federal Reserve, after Chairman Ben Bernanke mounted a strong defense of its economic stimulus this week, would blunt the effect of spending cuts.
"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.
What's more, markets have also been down this road before. In late 2012, investors and CEOs fretted over fears that the sequester, initially set 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 percent and the Dow up 7 percent since 2013 began.
"There's an element of fatigue in this whole process," said Gregory Whiteley, government bond manager at Double Line Capital in Los Angeles. "It seems there's a new scare conjured up every few months."
BELT-TIGHTENING
Economists are not as relaxed. Many say that government belt tightening will put a brake on economic growth this year, whether or not the sequester happens.
The Congressional Budget Office, whose calculations are the building blocks of many Wall Street forecasts, has estimated fiscal tightening will knock about 1.5 percentage points from economic 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 cuts would also hurt the labor market, which would end the year with 750,000 fewer jobs than it would have if the sequester were avoided, according to CBO estimates.
To be sure, 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 February 14.
"There are concerns about the sequestration causing a dramatic slowdown in the economy," said Dan Heckman, senior fixed income strategist at Minneapolis-based U.S. Bank Wealth Management. "The budget negotiation related to the sequestration adds a great deal of uncertainty."
Bernanke, speaking to lawmakers on Wednesday, urged Congress to try to push spending cuts further out to the future to shield a fragile economy.
"If you slow the economy that hurts your revenues. And that means your deficit reduction is not as big as you think it is," he said.
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 now appears to be how long the budget cuts will be allowed to happen. If budget cuts last only a few weeks, it is plausible they could have a marginal impact on growth and on employment. This is because some budget cuts won't 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.
President Barack Obama will meet congressional leaders in the White House on Friday for last-minute budget talks but hopes were low for a deal.
Whiteley said investors also realize that it will take months for furloughs and other cuts to be rolled out.
"If nothing happens today, that doesn't mean the economy crashes tomorrow. They have time to work on this," he said.
But perhaps not an infinite amount of time.
"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."
(Additional reporting by Ellen Freilich and Chikako Mogi; Editing by Tim Dobbyn and Chris Gallagher)
Source: http://news.yahoo.com/washington-frets-markets-spending-cuts-stride-050934215--business.html
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