The effect of sequester on US GDP is sizable but not huge, and we need to care about it, says Georg Grodzki, credit research head at Legal & General Investment Management in London.
Even if the effect is 0.5 percent (on the downside), which is the consensus reading, it’s not an insignificant number. The good news is that the US economy has shown very good signs of life so far this year. The US consumer sentiment is strong while latest data show the overall housing market has bounced back from the bottom.
The US economy is clearly in a much better position to take such a hit than it was a year ago. So at the end of the year, we could see an impact of 0.2 to 0.3 percent on the GDP, which is deplorable, but not that bad, Georg noted. Many investors in the US may actually find it encouraging that the government finally gets on the job of cutting deficits even though it’s doing so in a haphazard fashion, he added.
When pointed out the equity markets clearly didn’t price in the spending cut, as demonstrated by the recent rally, Georg said if you look at the global picture, growth is certainly going to be positive this year. The share of US economy in the global GDP is shrinking; so a 0.3-0.4 percent decline in US economy translates into less than 0.1 percent decline globally and hence one could shrug it off. Nonetheless, it’s significant and can’t be overlooked completely, he observed.
When asked if he expects the US sequestration to be a major event, similar to the recent inconclusive elections in Italy, Georg said the markets are well prepared for the aftereffects as it has long been coming.
Despite the gridlock over spending cuts, the US dollar has gained ground, indicating some people like the government getting on over the job of cutting deficits. The perception over the last few months has been: the less austerity, the better.
But, here in the US, many people feel relieved that future tax burdens and future fiscal cliffs will be reduced because somebody has got onto the job, albeit in a haphazard fashion, he noted. So it should not come as a shock for the markets, and even for the Italian elections, the volatility was a two-day affair, Georg added. The week has been positive on the balance and it’s important to carry the momentum forward because sequester is definitely going to dominate the headlines for the next few days.
Asked if political risks will be pushed on the back burner if central banks stand behind the markets, as indicated by the rapid recovery after the Italian debacle, Georg said hung parliaments are a part of a democracy. A hung parliament situation in the US resulted in sequestration because the upper house and the lower house were unable to agree on deficit reduction, and that’s what we have in Italy now. The markets should be used to them by now, he concluded.
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