Getting Down and Dirty with the Sequester

The U.S. Sequester has been the talk of town for the past few days. But what exactly is it?

It’s basically just a fancy term for spending cuts. The one which almost everyone seems to be abuzz lately, refers to the 1.2 trillion USD cuts that the U.S. government has started to implement last Friday and will be spread over the next TEN years. In its first year, the government has been tasked to save 85 billion USD.

You’re probably wondering why the U.S. government imposed this upon itself. Well, it started when the debt ceiling was raised in August 2011. Republicans pressured Congress in coming up with a long-term deficit reduction plan. The Budget Control Act was then signed into law which basically makes the cuts automatic as implemented by Congress Joint Select Committee on Deficit Reduction.

Despite signing the Budget Control Law himself though, President Barack Obama seems to think that it’s all a bad idea. He has been calling Democrats and Republicans, trying to convince both parties to come to a compromise and avoid the budget cuts.

USDX Chart

Interestingly enough though, it appears that the thought of automatic spending cuts and the threat of the government shutting down isn’t a major concern for the markets right now. Instead, market players are in risk aversion mode and are looking to unwind their risky positions in favor of the Greenback. In fact, when the sequester “officially” kicked in last Friday, we actually saw the USDX break past the 82.00 handle, marking a 300-pip rise over the past month!

Not that I blame them for thinking it’ll all blow over. After all, we’ve seen this happen time and again in the past – when the time comes to shuffle-up-and-deal, Congress eventually kicks the can down the road and comes up with a stop-gap measure to keep the government running.

Moreover, the markets know that the government must give a 30 day-notice to an employee before he or she gets laid off. That means if Obama pulls the trigger on the sequester today, job cuts will only really take place next April 4th. In effect, this buys the government 30 days to come up with a deal to come up with a compromise that may limit the spending cuts.

Over the next month, we’ll probably see the Democratic and Republican parties, led by Obama and House Speaker John Boehner respectively, to try and come up with a deal that both sides can live with. While I don’t expect the cuts to be eliminated completely, I do think some concessions will be made, such less spending cuts, possibly higher taxes, or some wiggling room to choose where spending reductions may come from.

The key data to mark on your calendars though is March 27. That’s when Uncle Sam will run out of moolah and possibly shut down. If that happens, all hell could break loose!

But for now, let’s just see what Obama and Boehner have up their sleeves and will bring to the table.