MARKET CORRECTION WARNING - The Fed Will Cut Economic Forecasts

By Markos N. Kaminis,

The Federal Reserve is on record discussing the economic impact of sequester spending cuts and austerity-like measures. However, the investment community may still not be prepared for what I expect the Fed to do on Wednesday, so this should be a value-added economic read. I expect a market correction starting as early as Tuesday and through at least to the 2:00 PM Fed releases, if not beyond. We broke this expectation in an article about Exxon Mobil (NYSE: XOM) earlier this morning at Seeking Alpha, and the market immediately began to look lower.

The Federal Reserve, through the Chairman’s semi-annual address to Congressional Panels, indicated that it agreed with the Budget Office’s estimated cost of sequester spending cuts on the economy. Chairman Bernanke suggested that the sequester cuts would likely cost economic growth 0.6%, and would contribute to a 1.5% drag upon economic growth this year caused by austerity-like measures, including the payroll tax break expiration.

The Federal Reserve’s most recent economic forecasts do not likely include sequester cuts, and might not include the impact of the failed fiscal cliff issues, including the expiration of the payroll tax break. In the Fed’s December forecasts, it projected Real GDP growth of 2.3% to 3.0% for 2013 and a slightly better pace for 2014. 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 only slight downgrade in growth expectation, it would seem the Fed’s December view did not include much of a weighting for the sequester failure. It might also imply a lack of inclusion of the other stimulus removal by the Federal government.

So, it seems that at least a portion of the 1.5% cost to economic growth is not included in the December forecasts. It would seem certain that the 0.6% drag was not included. Considering recent downgrades to Wall Street forecasts for corporate earnings this quarter, and the other economic considerations that need to be reconciled, there could be further reason to expect economic forecast cuts on Wednesday.

The run up of the stock market has been substantial this year, with the SPDR S&P 500 (NYSE: SPY), SPDR Dow Jones Industrial Average (NYSE: DIA) and the PowerShares QQQ (Nasdaq: QQQ) up 9.3%, 11% and 5.2%, respectively. However, if an economic question is posed Wednesday, and as speculation about this builds today, stocks should correct. Likewise, the securities which had been hammered during the stock market rise, for instance, the SPDR Gold Shares Trust (NYSE: GLD) and the iShares Silver Trust (NYSE: SLV), should gain. Still, Fed discussion may sooth the pain, if the Federal Reserve discusses a better long-term outlook. I advise investors to take appropriate action.

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