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On March 1, cuts will automatically be made to defence and other spending if no deal is reached to avert.Having seen the tax part of the fiscal cliff and the the debt ceiling go by so far without incident, the sequester is not the subject of much concern, it would seem.
In a note, BofA/ML FX and rates strategist David Woo gives three reasons why investors are too complacent.
- This is nothing like the Fiscal Cliff. The GOP could not win the tax part of the debt ceiling fight so they had to cave.
- The sequestration is the last chance for the GOP to make any kind of stand, which is why Paul Ryan and Ted Cruz have said it will happen.
- The Democrats want more tax revenue as part of any aversion deal. There’s no room for compromise.
In the event of either a full or close to full implementation of the sequestration, it is reasonable to think that consumer confidence will weaken further. Non-defence cuts will hit both discretionary and mandatory spending and defence cuts could involve significant lay-offs (Pentagon announced last week that it has begun laying off many of its 46,000 temporary and contract employees). Our model suggests that a decline of the Michigan consumer expectations to the level of summer of 2011 during the debt ceiling crisis could shave 1.2pp alone from consumption growth.
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