(By Mani) After the last-minute deal on the fiscal cliff, the focus now shifts to the debt ceiling negotiations, which may result in a moderate spending decline.
The recent deal on government revenues is unlikely to create too much of a drag and economists foresee QE continuing through 2013, albeit with some reduction in monthly magnitude later in the year.
"We still expect 2.3% real GDP growth this year followed by 3% in 2014. The key drivers ("bright spots") are positive QE effects on lending and pent-up demand venting, especially for housing," UBS economist Maury Harris said in a client note.
The debt ceiling has not been changed. Treasury said it hit the $16.4 Trillion limit on Dec 31. It can use various accounting manoeuvres that will likely allow extra borrowing authority until late February or early March.
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The IRS has said it hopes to announce "soon" whether it would be prepared to start accepting tax returns on time, given the recent tax legislation.
"That will matter for the timing of tax refunds, which typically start getting paid out beginning in late January, and, thus, for how far Treasury can temporarily exceed the debt ceiling with accounting manoeuvres," Harris noted.
There is no specific deadline date for the debt ceiling negotiations. In the past, the imminent arrival of the debt ceiling forced a resolution following the usual political posturing. This time is more problematic. The delayed sequestration hits March 2, which could potentially be linked to a debt ceiling deadline. A new continuing resolution to extend budget funding is due March 27.
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At this juncture, many wonder about the outcome of the negotiations on the debt ceiling? The worst outcome would be a default on US Treasury debt. A less bad option would be triggering the recently temporarily postponed $110 billion Federal spending sequester.
"Instead, I expect a very "last minute" "kick the can down the road" deal, which is far from the earlier hoped for $3-4 trillion "grand bargain" and possibly disappointing enough to trigger another Treasury debt downgrade," Harris noted.
Still, no one can be perfectly sure that any "last minute" deal will happen, which spells inevitable near-term uncertainty for households and firms.
Meanwhile, there has been a gradual shift in the Fed communication recently with the current monetary policy being made conditional on economic factors and with an arguably less dovish tone at the last FOMC meeting.
While some of the recently released December FOMC minutes about divided opinions on the duration of QE have been interpreted as hawkish, the voting FOMC will become more dovish in 2013 with the annual rotation of voting regional Reserve Bank presidents while QE is expected to continue through 2013.
"We believe that the Fed's recently announced 6.5% unemployment rate trigger for raising short-term rates is inadvisably high. However, only time and the evolving core PCE price inflation will tell who's "right" on this issue," Harris added.