As Washington frets, markets take spending cuts in stride

Fri Mar 1, 2013 6:15am EST
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By Steven C. Johnson and Jason Lange

NEW YORK (Reuters) - Broad spending cuts designed to slam most U.S. government programs with all the subtlety of a sledgehammer were set to begin taking effect on Friday, yet investors have so far barely batted an eyelash.

The $85 billion in across-the-board "sequestration" cuts were expected to cause airport delays, disrupt public services and result in lower pay or layoffs for millions of government workers.

What they were not likely to do, at least as far as financial markets were concerned, was cause enough damage to derail a U.S. economy that has lately been gaining momentum.

The prospect of weaker growth and a jump in unemployment caused by the cuts was also being seen by some in the markets as making it more likely the U.S. Federal Reserve will need to maintain its ultra lose monetary policy for longer.

"The market is of the view that if there's a fiscal tightening which causes a significant negative impact on economic prospects and the labor market, then the Fed will have to respond," said Ian Stannard, head of European FX strategy at Morgan Stanley.

Financial markets have also had a long time to assess the potential impact of the cuts on growth and believe it is not tantamount to a recession trigger.

"There is no immediate and visible impact to the economy so markets are not seeing it as a tail risk," said Ayako Sera, a market economist at Sumitomo Mitsui Trust Bank in Tokyo.

"It's not that money will stop circulating, unlike in the case of a debt ceiling where necessary government payments due will be suspended. So maybe time is needed for markets to digest the significance of the news, prompting investors to stay to the sidelines," she said.   Continued...

A screen on the trading floor shows the Dow Jones Industrial average after the closing bell at the New York Stock Exchange, February 1, 2013. REUTERS/Brendan McDermid