Fed Warning - Expect A Sharp Cut To The Economic Forecast

Includes: DIA, GLD, QQQ, SLV, SPY
by: Markos Kaminis

Expect the Federal Reserve to sharply cut its economic forecasts when it publishes them this afternoon. Since the Fed's last publishing, GDP was reported running at a sluggish pace in the fourth quarter, the Federal government allowed the payroll tax breaks to expire and let the sequester spending cuts pass through the system. The Fed is on record discussing the economic impact of these austerity-like measures, and it has measured them and they are substantial. Yet it would seem that the major media and economic experts have overlooked it. As a result, with stocks having run so far this year, they could come under pressure today. Though some believe that bad news is good news, and that anything that allows the Fed to stick with its dovish tone is good for stocks, I think we'll soon know the answer to that question. But let's explore why I think the economic forecast is about to be sharply reduced.

Fourth quarter Real GDP growth was just 0.1%, deeply short of economists' expectations for a 0.5% increase. Obviously, much of the miss can be attributed to a paralyzed state in Washington D.C. It's an issue that put the full faith and credit of the United States at risk with the debt ceiling issue. It threatened to put the economy into recession around the fiscal cliff. And it certainly paralyzed small businessmen and large corporate spending plans, and so stalled economic growth. It may have likewise impacted the first quarter, though to a lesser degree, and so would be a weight on economic growth this year. It is an issue that may not be fully included in the Fed's prior forecasts.

Furthermore, the Federal Reserve chairman's semi-annual address to Congress recently indicated that it agreed with the Budget Office's estimates regarding the economic drag likely to result from sequester spending cuts. Those cuts alone are expected to burden economic growth with a 0.6% drag. The Fed Chief said that the sequester cuts were just part of a 1.5% drag on economic growth this year brought on by the federal government's austerity-like measures, including its allowing of the payroll tax break to expire.

I am comfortably certain that the Federal Reserve's most recent economic forecasts published in December do not include sequester cuts, and might not include the impact of the payroll tax break expiration either. In the Fed's December forecasts, it projected Real GDP growth of 2.3% to 3.0% for 2013. It's important to note that the Fed's December forecasts marked only a slight revision lower from their September view, with the 2013 estimate at that time set for 2.5% to 3.0%. Because of the just slight downgrade in growth expectation in December, it would seem the Fed's December view did not include much of a weighting for the sequester failure nor the payroll tax break expiration. Thus, it seems that at least a portion of the 1.5% cost to economic growth was not included in the December forecasts, and at least the 0.6% drag was not included.

Other anecdotal evidence of economic issue is clearly present in the information stream as well. For instance, Wall Street has been aggressively cutting corporate EPS forecasts for this quarter, according to FactSet. I recently reviewed several economic considerations that need to be reconciled, that I offer again here as recommended reading.

An economic question could be posed Wednesday that perhaps investors have not considered. The SPDR S&P 500 (NYSEARCA:SPY), SPDR Dow Jones Industrial Average (NYSEARCA:DIA) and the PowerShares (NASDAQ:QQQ) all evidence a market with an underlying expectation for economic improvement. Even today, each of the broader market measures is higher by nearly a half of a point. Asset classes and securities which have served as resources for capital are likewise lower today. For instance, the SPDR Gold Shares Trust (NYSEARCA:GLD) and the iShares Silver Trust (NYSEARCA:SLV) are each in the red by nearly the same margin that broader equities are higher. Perhaps bad news is good news, but I feel as though the broader public is not aware of what I believe the Fed will say regarding the economic outlook. I expect a significant cut to this year's economic forecast. Add to that the fact that the ECB just cut its expectations for 2013, and you have an important economic question posed. Is global economic recovery really within sight yet?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.