The US economy is currently experiencing an expansion since the recession in 2009, but there are speculations from economists who are worried that this expansion will soon be ending. We can expect an economic slowdown in 2013, but it is not yet known how drastic it will be. These economists are predicting a recession starting in 2013 and the “fiscal cliff” will be a determination of where our economy is headed. Below is a chart of the important forecasted indices for both 2012 and 2013. The Fiscal Cliff of 2013 What economists are calling the Fiscal cliff of 2013 is the combination of upcoming deadlines to major tax cuts and budget cuts.
These fiscal stimulus measures — including the Bush-era tax cuts, the 2010-2011 payroll tax cut and extended unemployment insurance benefits — will expire at the beginning of 2013 unless Washington renews them. Congress created the conjoined deadlines on tax and spending policy as a way to prod itself to resolve long-running disputes on fiscal issues. Negotiations have stalled over President Obama’s demand for higher tax rates for top earners and congressional Republicans’ insistence on structural changes to entitlement spending. Congress and President Obama must reach an agreement by the year end to resolve these issues and speculations.
But whatever ultimately happens, the uncertainty leading up to the resolution will likely keep investors and businesses on edge for the remainder of 2012, as they were during the debt ceiling debacle in mid-2011. Despite the speculations and fear of a recession, this fiscal cliff can be better phrased as a fiscal slope because this change will gradually happen over the year not just all at once. Major Risk Factors The major risk factors going forward that will determine the path of the economy will mainly be based upon the decisions of President Obama and Congress in regards to the fiscal cliff.
If these tax cuts are not renewed, our economy may see a drop in GDP. The total of all expiring tax cuts amount to about 5 percent of the U. S. gross domestic product. A drop in the US GDP will result in a deep economic contraction. The forecast shows a drop in GDP growth from 2. 20 in 2012 to 2. 00 in 2013, but the fiscal cliff will be a major factor in the actual result. The Federal Funds rate has seen no change and remains at . 25. The unemployment rate is expected to drop next year, meaning that there will be more job opportunities and will help to strengthen the economy.
The forecast for 2013 also shows rising interest rates for 2-yr Treasury notes as well as 10-yr notes. This means that credit is tightening and we will have a tighter monetary policy. Holders will be more inclined to sell US treasuries rather than buy them, and therefore there will be less money in circulation. I agree with these forecasts and based on my analysis predict that these numbers will continue to drop over the next year. The agreement between President Obama and Congress will determine how severe the drop will be. Yield curve The yield curve is an illustration of the relationship between the yields of bonds of different maturities.
The current yield curve on United States Treasuries is considered normal or positive. This is depicted in the red and blue lines in Figure A. A normal or positive yield occurs when the yield on long term securities is greater than that of short term securities. The shape of the yield curve for Walt Disney (DIS) bonds is similar to the U. S. Treasury yield curve. For Walt Disney, long term rates are greater than short term rates. But the yield curve for DIS bonds differs from that of the U. S. Treasury yield curve in it being slightly humped for bonds that mature between 15 and 30 years from now.
This relationship is depicted by the green line in Figure A and the green line in Figure B. Yield spread is the difference between yields on differing debt instruments, calculated by deducting the yield of one instrument from another. The higher the yield spread, the greater the difference between the yields offered by each instrument. The spread can be measured between debt instruments of differing maturities, credit ratings and risk. The yield spread on a 7 year DIS bond, as compared to the US Treasury bond is 4. 4 basis points. This yield spread is displayed pictorially in the graphs in Figures A & B, and mathematically in Figure C.
The spread of 4. 4 basis points shows us that investors expected a return on the 6 year DIS bond that is higher than the treasury bond. This is because the DIS bond has more risk associated with it. Unlike the Treasury bond, the DIS bond has default risk. Other risks associated with the DIS bond are liquidity problems due to potential infrequent trading. Therefore this spread of 4. 4 basis points represents investor’s compensation for credit risk. For fixed rate bonds, spread duration is often computed to predict how a non US Treasury bond will be affected by market changes, or, a change in yield.
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