We discussed earlier about the Fed's ZIRP policy and the transmission mechanism through which its free-money ends up in the real-economy (or not as the case in point). Brevan Howard agrees that the outlook for the US is not plain-sailing and that US growth does indeed face cross-currents, with the labor market improving at a steady pace while aggregate demand slows. While the firm remains more stoic, seeing a generally favorable macro backdrop, they note three uncertainties and one certainty that keeps them up at night. The pace of the drop in unemployment against only trend growth leaves its sustainability uncertain; the potentially temporary easing of the European financial crisis seems increasingly uncertain; and the growing tensions in the Middle East and the uncertainty over gas prices derailing the fragile economy. However, it is the one certainty that worries us most (and them, it seems), and that is the enormous fiscal drag the US faces in 2013 which unchecked could reduce real GDP growth by more than 3 percentage points. Even if the President and the new Congress cut this by half it would still be a noticeable drag on growth.
Looking forward, we believe that the US economy faces three uncertainties and one certainty. In terms of the uncertainties, the unemployment rate has dropped rapidly despite growth being around trend, calling into question the sustainability of this drop. Second, the European financial crisis has eased somewhat but the respite may again prove to be temporary. Third, geopolitical tensions in the Middle East could push up gasoline prices by enough to derail the expansion.
One certainty in our view is that the US faces an enormous fiscal drag in 2013.
Personal taxes on income, dividends, and capital gains are scheduled to rise sharply; across-the-board cuts to discretionary and defence spending will automatically kick in; and the payroll tax holiday and extended unemployment insurance are due to expire. This combination is likely to subtract more than 3 percentage points from real GDP growth. The question is whether the President and the new Congress will postpone some of these measures, however even if the fiscal drag is cut by half, it would still have a noticeable impact on growth.