US Fiscal Cliff And It’s Impact On The Outlook For 2013

The prospects of the US economy will have a significant impact on the global recovery and the outlook for 2013. The US is facing the prospect of a fiscal cliff which comes into force on 1 January 2013 in the form of $600billion automatic tax increases and spending cuts in order to tackle the nation’s huge deficit. Congress will need to agree a new deal to mitigate the effect of these automatic taxes and cuts. Critics are concerned that the extent of the automatic measures imposed will send the US economy into a deep recession as the fragile economy is unlikely to cope.

This is not the first time the US has been faced with a fiscal cliff.  Congress successfully managed to agree a compromise position last time the economy was faced with this position and we expect that a similar position will arise this year whereby the politicians will successfully manage to kick the can down the road for another year or so.

Whilst an outright US recession is likely to be avoided, we can expect increased taxes and spending cuts in the US in 2013 as part of the deficit reduction plan although not to the extent of the automatic cuts implicit under the current arrangement. The US healthcare and defence sectors are likely to suffer and so contractors and small businesses would be advised to reduce their exposure to these areas where possible.

UK Economic Update

France lost it’s AAA credit rating last week following a downgrade by ratings agency Moody’s. The news came in light of France’s vulnerability to the Eurozone debt crisis and concern over whether high labour costs will stifle France’s economic recovery. Many fear that the UK will be next in line to be stripped of it’s AAA credit rating.

The UK economy has been in recession for 5 years and has undergone very low levels of growth despite several attempts by the Bank of England to pump money into the system in the form of Quantitative Easing (QE). The QE program has not worked as the cash has not filtered down to small businesses to enable growth. The economy is now at risk of inflation which can already be seen in the form of higher prices filtering into the system. Fuel and food prices in particular have been rising whilst wages are being squeezed.

The UK is saddled with high levels of debt and will risk losing it’s credit rating unless a credible plan is put in place. Last month’s news that the government is spending more than it is collecting in taxes is of particular concern, hence the recent outcry against large multinationals such as Starbucks who are not paying their fare share of taxes in the UK.

We expect that the UK will embark on several new infrastructure and housing projects in order to provide added stimulus to the market. However, this is unlikely to be provide a significant long term solution to the budget deficit. The HMRC will continue to target tax avoidance but we feel it is unlikely that they will employ any meaningful transfer pricing policies in the near future to bring the large multinationals onto a level playing field with domestic businesses.

Quantitative Easing Continues To Damage Pension Funds

The Bank of England’s (BOE) decision to print more money to help the economy has created significant side effects including rising inflation and a shortfall in private pensions. In summary, the BOE prints money and uses it to buy government and other bonds. This has the effect of increasing the demand for government bonds and so the interest rate offered for these investments falls to reflect the relationship between supply and demand.

Pension plan benefit liabilities are valued with reference to the interest rates available on government bonds. The lower the interest rate the higher the value of the liabilities of the scheme.  The return on the pension scheme assets on the other hand will be reduced by the inflationary effects of Quantitative Easing (QE). Therefore pension funds are faced with the prospect of a fall in asset value combined with an increase in the pension scheme liabilities, thereby creating a pensions black hole.

Savers have been having a hard time recently. The continued QE and rising inflation has hit pension funds hard and low interest rates mean that it is difficult to earn a reasonable return on your investment. So what can be done? Unfortunately we cannot control whether the BOE or the FED or the ECB continue to print money. In fact we are resigned to the fact that they are likely to print more money soon as both the US and Europe have pledged to embark on programmes of ‘unlimited QE’.

We recommend that you look at the one aspect that you can control (to an extent), and that is the return on your pension fund. If you are not doing so already you should be monitoring the returns on your investments. Most pension funds provide online access whereby you can review the performance of your plan. If you are using a fund manager and are not happy with the performance then consider changing them. There are regular reports in the media that suggest fund managers are investing in bonds that will generate very low and even negative returns. There is a chance that your pension is being managed by these fund managers and if so you should seek to change.

Certain SIPP pensions offer significant flexibility in the range of methods you can use to invest your funds. Also, given that pensions are adversely affected by inflation you could diversify that risk by investing in gold funds. This is a natural hedge because the price of gold should increase in the event of QE and inflation and so the gold miners are likely to benefit.

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