Will Washington kill the rally?

Automatic spending cuts known as sequestration will hit March 1 unless Congress and the White House can agree on a new spending plan. Markets are betting the cuts won't take place -- and could be rattled if they do.

By Charley Blaine Feb 8, 2013 10:08AM

Graphic by Ryan Jeffrey SmithUpdated: 2:07 p.m. ET


Sequestration. Don't fall asleep over the word. It may well happen, and, if allowed to fester, it could cause quite a bit of economic mischief.

 

No, not as much as a government shutdown, which may come at the end of March. But a serious problem nonetheless.

Sequestration is the dreadful word used to describe the automatic spending cuts required under the 2011 budget bill if Congress and the White House can't agree on a budget plan. The plan came after a near-default on U.S. debt.

 

So far, no one has begun to talk seriously about a realistic budget plan. So either the cuts will kick in, or Congress will opt to delay the decision.


Financial markets appear to be betting on delay because there is increasing reluctance in Congress to derail the economic recovery. That's one reason why the stock market, while weaker this week after a recent rally, isn't in free-fall.


The bigger worry is that a full-scale fight over the $16.4 trillion debt ceiling will erupt. Again, the resolution depends on how Democrats and Republicans weigh the political risks. The budget battles are really over who gets to be in charge.

"Seriously, control of the House two years from now is the underlying theme in this entire sequester debate," Greg Valliere, chief political strategist at Potomac Research Group, wrote clients on Friday.

Refusal to lift the debt ceiling would force a shutdown of non-essential functions of the government. That would have very damaging effects on the economy, says Greg Daco, a senior economist at IHS Global Insight.

If sequestration happens, it requires across-the-board budget cuts evenly split between defense and non-defense spending. The defense budget would be cut 7.3% off current levels. Medicare would absorb a 2% cut, and the rest of the federal budget would be cut 5.3%.

In dollar terms, we're talking about $55 billion a year in defense cuts through 2021 or whenever a new spending scheme is put in place beforehand.

This would probably not have much effect in March. But Daco says the sequester could cut economic growth by 0.4% if allowed to run through the end of the year. Indirect effects would result in an additional 0.1% cut.

It is enough of an issue that the U.S. Navy is delaying sending the aircraft carrier Harry S Truman to the Persian Gulf and will keep it moored in Norfolk, Va. Since 2010, the Navy has kept two carriers on duty in the gulf at all times.

It is also enough of an issue that some 800,000 Pentagon employees would be put on four-day work weeks, the Economist says. Every Pentagon contract will need some renegotiation for at least the next six months. It would probably mean reduced hours or layoffs at virtually all defense contractors.

Reduced paychecks would mean reduced consumer spending, particularly in communities with large defense installations such as San Diego, San Antonio Seattle, Honolulu and Norfolk. So a prolonged sequestration would slowly eat away at whatever economic progress these markets have seen in, say, the last 18 months.

It's not entirely clear how non-defense spending would be affected if the sequestration persists. There are hints, however.

The University of Michigan expects that sequestration would mean substantially less research money available. Its success rate at winning grants from the National Science Foundation would fall from 22% to 16% and from 19% to 14% for grants from the National Institutes for Health.

Education funding would be cut or eliminated. Aid to states and local communities would be reduced as well. You would see reductions in services in national parks and the like.

If Congress failed to raise the debt ceiling, the result, says IHS economist Daco, would be "a very very big direct impact on the economy."

While the stock market overall was down only slightly for the week after Thursday, investors in defense stocks are more worried.

The SPDR Aerospace and Defense (XAR) peaked on Jan. 25 and is off 4.5% since then. Lockheed Martin (LMT) was off nearly 9% as of Thursday from its peak on Jan. 24. General Dynamics (GD) is off 6.6%. Raytheon (RTN) has fallen 7% while Northrop Grumman (NOC) had fallen 4.4%.
36Comments
Feb 8, 2013 10:56AM
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We have so many contracts, so many obligations, and so many unneeded expenses in our Government....We don't even have a way to gauge where it all goes...

 

Billions of cost can be cut with out losing any valuable players/workers or hurting the pay or living of our Military personal..

We have silly pork and individual grants, that cost us in the tens of Millions...

IE;  Such as "counting the legs on a Centipede.."

Or how much beer evaporates at the Super Bowl...?

Feb 8, 2013 11:19AM
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CONGRESS NEEDS TO BE FIRST IN LAYOFFS!

They don't work anyway, Florida Frank

Feb 8, 2013 2:13PM
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Well we need to do something for the good of the whole country. Cut bloated, wasteful defense spending now.  We are not the worlds police. We create more US hatred than good with our military and their goofy policies. What did we gain with the trillions spent in the Iraq war? Do you feel any safer now? I don't. We don't really care about democracy abroad just so we get something like oil from them is what really matters. Quit exporting petroleum products from the US. Keep our own oil and become energy independent with various sources. Keep our technology in the country as China is just stealing it for their own good.  Take care of our own house first.
Feb 8, 2013 12:45PM
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"Refusal to lift the debt ceiling would force a shutdown of non-essential functions of the government. That would have very damaging effects on the economy, says Greg Daco, a senior economist at IHS Global Insight."

 

What the article is really saying is the economy is based on non-essential functions of government If  Sequestration would stop non-essential functions of government and have a damaging effect on the economy. That's really the whole problem. Our economy is a farce based on selling non-essential toys and services like Direct TV, smart phones and tablets to children and other consumers that have no productive use for those devices or services. It's an economy based on Christian wars and consumer Ponzi schemes like Apple's iToys and pay per view cartoons.

Feb 8, 2013 10:47AM
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Well I've got to the point of turning my back on all this....Reminds me of the Grecian Tales..

 

The only part that I figure could have major impact is Defense and defense spending...?

DEFENSE SPENDING.....NEEDS to be REINED IN, like a wild horse..

If we quit building a few hundred Aircraft, thousands of vechicles, a couple of ships..SO BE IT !!

 

If Pentagon employees go down to 4 days a week...So BE IT.

If we have to retire a couple hundred Generals...So Be it..

These Public employees and an overbloated Military...Are some of the few, that have not taken cuts.

It's not a high paid job, guaranteed benefits...FOR LIFE...Not any MORE...Shouldn't BE.

Feb 8, 2013 2:15PM
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When the FED stops printing, the bloated "Rally" will shrivel...
Feb 8, 2013 2:52PM
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the need to reduce spending has to be done--the time of blaming everybody else for the state of our country is over, If the only way to reduce government reckless spending of our money is through sequestation ,then let it happen.


Feb 8, 2013 3:23PM
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DOD could easily cut 20% and we would never notice.  drop 2, 3 old navy ships.  drop 2, 3 flight squads.  drop 2, 3 army bases. 
Feb 8, 2013 3:00PM
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10% cuts across the board would just be a starting point for me//////////////////// Hell the economy isn't growing

anyway so we might as well get our house in order and then let the economy roar///////////// That will probably

be in 4 yrs was Odumbo has finally left the building------------

Feb 8, 2013 1:59PM
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Here it is, it's 85bil per year decrease. We spend 3 trillion per year. 50 bil decrease for military.

All this is is a decrease in the automatic increase of 8%. This is nothing, only change I would do is all of the decrease should come on domestic spending. 3 trillion is 3000 billions!

Feb 8, 2013 5:38PM
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Let the cuts begin!  Somone will always complain when cuts take place and the Chicken littles of the world will always claim the sky is going to fall when the cuts start.  When is the last time the US balanced it's budget (1950s,1960s,1970s)? 
Feb 8, 2013 5:17PM
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Yes.............. Turn out the lights.. The party's over.
Feb 8, 2013 8:12PM
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Hmmm... no one is talking this up yet. Know why? The BEST course is to get off the horse and let it run on it's own. Banks exist because the government intervened. Imagine banks suddenly having to collect their own credit extension in a vacuum. Markets would fail and crooks tapping fund monies would go to jail. Shorts would pay off. All those expenses everyone wants cut would freefall. When they are flat out broke, we can cherry-pick the ones we want. The GOP would be on their knees and the House would drop the BS and  come to the table or risk being pulled out into the street by their own contributors. So with that in mind, what do YOU think the odds are of the President signing off on anything less than exactly what he wants? The Party of NO has no way to go, they did it to themselves.

I attended a presentation by Potomac Partners in 2007. They were spot on. Hundreds of Kool Aiders in the audience. If Greg Valliere is of the same entity I'm inclined to believe his perspective. Researchers are a dime a dozen. Sober researchers with the guts to speak against the grain are a true asset. BTW Greg, not sure who YOU think will control the House, but I doubt it will have any Tea Baggers, far fewer if any Republicans and perhaps as few if any Democrats. Without change we can actually do something with, I don't see any existing party surviving this next election with any winners. I honestly think Average Citizen could obtain the necessary petition signatures to run and win without any campaigning at all. He or she would be the viable None of the Above alternative. Career politicians are all done.

Feb 8, 2013 11:58PM
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Teachers, Cops and Other Public sector Employees, I'm not going to even waste my time getting into that discussion...If you're good, you're good...If not you should be fired or replaced..Very simple.
Feb 8, 2013 11:49PM
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Touched a nerve about cutting the bloated Military...And then some of the Federal Sector employees on the Dole, paid my Americans taxpayers like myself, others and also maybe the ones that commented..??

 

First off ZZook, he thought I should join the Military and Serve my Country....He doesn't know me and apparently had a lot of trouble understanding what I ACTUALLY wrote...

Zookie.....I'm a Disabled, Decorated, Combat Veteran from a different War and a different time..

I am also a Life member/member of many Service Organizations...I am not a HERO..

I have been home a long time...And thankful....The Heroes names are on Walls & Plaques.

Or Headstones...

I've always supported the Military and our Commander-in-Chief...Even when I didn't like him...

I stated the Military Industrial Complex...Needed several cuts...The Pentagon is bloated and overstaffed with useless Generals, HIgh paid staff and people that accomplish little, but have a job for life and they know it..

We are Building Military, conveyances and weapons, that will be outdated or un-needed before they are delivered and we have twice as many as everybody else.....Get a grip son !!

I was never trying to take anything away from our young and fighting Military and their families.

Feb 8, 2013 3:17PM
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Boehner and Cantor ... do they have the maturity  and sense to vote for America,
Feb 8, 2013 1:21PM
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If sequestration is the only way to cut that bloated, wasteful and unnecessary military spending, then I welcome it with open arms.

 

Repukelicans will never cut 1 cent from military spending, not ever. PATHETIC REPUKELICANS!

 

DIE CORRUPT MILITARY COMPLEX, DIE!

 

 

Feb 8, 2013 1:28PM
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I also love to see how all the paranoid and schizophrenic anti-government and conspiracy theorist Repukelican "SURVIVALISTS'", always wind up DEAD after any confrontations with the law.

 

So much for that "SURVIVALIST" mentality! LMAO

 

DIE REPUKELICAN SURVIVALISTS, DIE!

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