Fundamentals Update: US Budget Deal December 2013

US Budget Deal December 2013

Fundamentals Update as at 13 December 2013 by Lorenzo Beriozza

Yesterday, Paul D. Ryan (Republican) and Patty Murray (Democrat), chairs of the House and Senate Budget Committees, respectively, agreed on a compromise on discretionary fiscal spending for the next two years. Under the deal, the discretionary spending caps for the current and the next fiscal year (2014 and 2015) will be raised by a total of $64 billion. The additional spending will be split evenly between the defense and non-defense budgets. The automatic spending cuts, which both parties dislike, will be reduced. The higher spending levels for the next two years will be financed by cuts in other areas and revenue increases. However, these measures will span ten years and are therefore subject to a number of uncertainties, whereas higher spending over the short term is a certainty. As a result, the intended deficit reduction of $23 billion over ten years is rather a vague hope. Moreover, the planned deficit cuts would reduce the aggregate $6340 billion deficit projected by the CBO for this period only by 0.4%. Still, some of the savings measures target the right items. For example, pension contributions for federal employees who are hired from 2014 will be increased and pensions for soldiers who retire before they turn 62 will be reduced. This is a small step towards the necessary cuts in mandatory spending.

The overall volume of the agreement (expenditure increases worth 0.3% of GDP in 2014 and 0.1% of GDP in 2015) is quite modest. What makes it important is that it has been reached at all. The agreement will probably pave the way for a relatively smooth hike of the debt ceiling, which will re-enter into force on 7 February 2014. The House will probably vote during the remainder of this week. The vote in the Senate might take a bit longer, but should take place by the end of next week. While some further delays cannot be ruled out, Congress will in all likelihood accept the deal. This “ceasefire” agreement will remove a major source of uncertainty, which has weighed on growth in the last few years. Political uncertainties, which are regarded as a key reason why US companies have been reluctant to invest for some quarters now, are now significantly reduced. Chances that growth will accelerate next year will improve further as well. The Fed has always emphasised that it regarded the fiscal dispute and the fiscal uncertainties as major risks for the US economy in 2013. The escalation of the fiscal dispute in September probably played a major role in the central bank’s surprise decision to continue asset purchases. Yesterday’s agreement will remove the political risks in connection with budget conflicts for 2014 at least. Thus, an important reason to delay the exit from the unconventional monetary policy is no longer valid – and at the same time, the economic data point to a pick-up in growth. This development increases the pressure on the Fed to start tapering soon. Whether the decision is taken next week or at the beginning of 2014 is of minor importance. It is clear that the QE3 measures will be scaled back at one of the upcoming two to three meetings. And thus attention will refocus on the question whether the Fed can successfully promise the markets low rates for a prolonged period of time. Only then will yield increases on the financial market remain limited.

Source: Commerzbank
2017-05-04T22:20:19+00:00