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Economic and Market Review

By: Ryan McCarroll
Risk Analyst

The year came to a close without a resolution to the highly anticipated “fiscal cliff.” In vintage Washington fashion, a deal was struck at the 13th hour with the Taxpayer Relief Act signed into law on New Year’s Day. The deal left the majority of the Bush era tax breaks intact for individual tax payers making less than $400,000 or $450,000 for households. While the marginal tax rates were left largely unchanged for most Americans, the payroll tax holiday quietly expired without any fanfare. This will be an unwelcome surprise for many consumers receiving their first paycheck of the year and could negatively affect first quarter consumer spending.

The resolution did provide a reasonable amount of clarity regarding taxes for the foreseeable future. Unfortunately, the market outlook will remain at the mercy of Washington for the next several months as the spending and the debt ceiling issues were left for another day. The deal postponed the sequestration cuts until March 1st, near the same time the Treasury is expected to hit the debt ceiling. The debate is shaping up to be very reminiscent of the clash in 2011 when the debt ceiling was last reached and the U.S. was downgraded by S&P.

As mentioned in previous commentaries, business investment and hiring decisions are often precluded with high levels of economic uncertainty. Along those lines of logic, a compromise to curtail the deficit could be a catalyst for some business leaders to come off the sidelines. If a compromise does happen without damaging political posturing, 2013 could be brighter than many expect.

The U.S. labor market added 155 thousand non-farm payrolls in December, which brought the total increase during 2012 to 1.84 million. These are modest gains relative to the amount of unemployed Americans, but the gains were reasonably steady throughout 2012. On an encouraging note, both weekly and hourly earnings improved more than expected in December. Year over year improvements to average weekly earnings were 2.04%, perhaps suggesting that businesses have improved their outlook enough to increase pay and expand hours.

Finally the Federal Reserve released its Federal Open Market Committee (FOMC) minutes, which contained interesting language that suggested it expects QE3 to begin winding down by the end of 2013. However, take caution when interpreting this type of language as the Fed also recently changed its rate guidance to “data conditional” in lieu of a set time frame in which it would keep rates near zero. The current interest rate environment and asset purchases will only change insofar as the economic forecasts used by the Fed are correct.

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