October 10, 2012Daily Rates & Viewpoints From the Officers & Staff of TIB.

The Fiscal Cliff

The “Fiscal cliff” is a term that is used to describe what the U.S. government could face at the end of 2012 when the terms of the Budget Control Act of 2011 are scheduled to go into effect. If an agreement cannot be reached before midnight on December 31, 2012 automatic budget cuts will go into effect and the spending cuts agreed upon as part of the debt ceiling deal of 2011 will begin to go into effect. The impact from these cuts is still unknown.

Some of these changes include new taxes related to President Obama’s health care law, the end of last year’s temporary payroll tax cuts, the end of certain tax breaks for businesses, changes in the alternative minimum tax, the end of the tax reductions enacted in 2001-2003 and additional cuts to many different government programs. This includes significant cuts to the defense budget that has already been trimmed considerably and cuts in Medicare funding.
The Congressional Budget Office (CBO) projects that under the current law, a sharp reduction in the federal budget deficit between 2012 and 2013 will cause the economy to contract, but will also put the federal debt on a path that is more likely to be sustainable over time. To illustrate the effects of fiscal tightening, the CBO compared its projections under the current law (the baseline projections) to projections under an alternative set of policies which represent two scenarios in a broad spectrum of choices.
CBO 2012 Baseline Projections – Reflects the assumptions that the current laws remain unchanged. This implies that lawmakers will allow tax increases and spending cuts scheduled under the current law to occur and that they will forgo measures routinely taken in the past to avoid such changes. Under this plan, the current 2012 deficit of $1.128 Billion would be reduced to $641 Billion in 2013 and this represents a $487 Billion reduction.
The change in inflation adjusted GDP from the 4th Qtr 2012 to the 4th Qtr 2013 is estimated to be down -.5% and unemployment is expected to be 9.1%. Over the next 10 years, Federal debt held by the public (as a percentage of GDP) which currently stands at 73% in 2012 would decline to 68% in 2017 and to 58% in 2022.
Alternative Fiscal Scenario – Maintains what might be deemed current policies, as opposed to current laws, implying that law makers will extend most tax cuts and other forms of tax relief currently in place, but set to expire and that they will prevent automatic spending reductions and certain spending restraints from occurring. Under this plan, the current 2012 deficit of $1.128 Billion would be reduced to $1.037 Billion in 2013 and this would result in a $91 Billion reduction.
The change in inflation adjusted GDP from the 4th Qtr 2012 to the 4th Qtr 2013 is estimated to be up +1.7% and unemployment is expected to be 8.0%. Over the next 10 years, Federal debt held by the public (as a percentage of GDP) which currently stands at 73% in 2012 would increase to 83% in 2017 and to 90% in 2022.
The scenarios mentioned above are just two the CBO has considered. Other scenarios run by the CBO have shown that the new policies scheduled to be enacted at year end would reduce GDP by 4-5%. U.S. lawmakers must make a decision as to what they will do and it is difficult for investors to plan in this environment of uncertainty. The choices our legislature can take are tough and none of these are particularly attractive. Here are a few of the options that are considered likely.  
·         They can decide to do nothing and the policies set to expire on December 31, 2012 and those automatically set to be enacted on January 1, 2013 can go into effect. These include a number of tax increases and spending cuts that are expected to negatively affect growth and possibly drive the economy back into a recession. The benefits of this approach would be the reduction in the deficit, (as a percentage of GDP) it could be cut in half.
·         They could selectively cancel some or all of the scheduled tax increases and spending cuts. Based on the CBO’s estimates, reductions in taxes or increases in spending in 2013, relative to what would occur under current law, would have near term economic benefits, but would add to the already large accumulation of government debt. Because current policies would ultimately lead to an unsustainable level of debt, policymakers will need at some point to adopt policies that will require people to pay significantly more in taxes, accept substantially less in government services or both.
·         They could take a blended approach that would address some of the budget issues, but would not cut spending as severely as planned. This could avoid some of the negative effects on GDP and unemployment, while still making some headway on reducing the deficit.
These choices present different challenges for managing our banks and specifically investment portfolios. If you would like to discuss this, please contact your TIB Capital Markets representative.

Eric Allen Eric Allen
Sr. Vice President

Market Levels @ 8:45 AM CDT

TIB Fed Funds & MMDA Rates - Previous Day
Agent 0.20% Prin 0.05% MMDA 0.30%
STAR Prin 0.10% STAR MMDA 0.35%
Key Indices/Commodities
1 - Month LIBOR 0.21% Dow Jones 13433.90
3 - Month LIBOR 0.34% NASDAQ 100 3061.20
1-Yr LIBOR 0.94% S&P 500 1436.30
1-Yr CMT 0.18% Spot Gold 1763.10
Prime 3.25% Spot Silver 33.87
3-yr LIBOR Swap/Offer 0.46% Spot Crude Oil 92.31
5-yr LIBOR Swap/Offer 0.80% CRB Index 309.12
3 Mo - Fed Fund Futures 0.13% 6 Mo - Fed Fund Futures 0.12%
US Treasury Yields US Non-Callable Agency Yields
Yield Maturity Yield Spread
0.00% 90 - Days    
0.04% 180 - Days    
0.21% 2 - Year 0.25% 4bp
0.31% 3 - Year 0.38% 7bp
0.64% 5 - Year 0.79% 15bp
1.70% 10 - Year 1.99% 29bp
2.91% 30 - Year    
149 BPs Yield Curve(2's-10's)
Sample 1x Callable Agency Issues
Description Call Date YTC YTM
FNMA 1 10/29/18 10/14 1.00% 1.00%
Select MBS Levels
Description Coupon Yield Spread/Duration*
15-Yr FNMA 3.00% 1.36% 86 / 3.72
30-Yr GNMA 3.50% 2.31% 69 / 7.73
*Duration @ 12 month Historical CPR
Morning Commentary: Reed Bateman

Yesterday’s 3-year note auction was strong, but we’re seeing Treasuries sell off a bit before today’s 10-year auction. $32B of the 3-year notes sold yesterday at a yield of 0.346%, and the bid-to-cover ratio was the highest on record at 3.96. The average bid-to-cover for the last ten auctions was 3.56. We expect demand for $21B of the 10-year note to be strong today as well. The 10-year yield remains near the middle of the recent trading range of 1.60-1.86%. Wholesale inventories increased by 0.5% for August, slightly more than expected, but were revised down a tenth of a percent to a 0.6% increase for July. Mortgage applications declined 1.2% for the week ending October 5th, which was a little surprising after a 16.6% increase the prior week and with mortgage rates remaining near record lows.

Information contained herein is based on sources we believe to be reliable but its accuracy is not guaranteed. Customers should rely on their own outside counsel or accounting firm for specific circumstances. The securities, yields or levels discussed herein are for illustration purposes and are not guaranteed, not obligations of any bank, thrift or other entity and are not insured by the FDIC.

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