Will sequestration kill the stock market rally?

(MoneyWatch) Nineteen months after it was originally conceived, sequestration week has finally arrived! (Check out this handy sequester Q&A for more details.) Unless a last-minute deal occurs in the days ahead, the government will implement the first phase of across-the-board spending cuts, which will amount to $85 billion in 2013.

My favorite news producer calls sequestration the U.S. version of European austerity. Of course, things haven't worked out too well across the pond, where drastic eurozone budget cuts have slashed economic growth and caused unemployment to spike. Last week, the European Union said it expects that the 17-nation eurozone bloc will likely contract by 0.3 percent this year amid 11 percent unemployment. It would be the second year in a row and the third year in the last five that the region has been in recession.

The results of European austerity should be a warning to those who think that sequestration wouldn't be that big of a deal. The blunt cuts are likely to slow economic growth by 0.5 percent and cause job losses of 750,000. While sequestration is not likely to derail the economy enough to cause another recession, real people will suffer direct effects and many others will encounter indirect effects. (Note to travelers: Airports are likely to be a mess in the aftermath of sequestration!)

It is either amusing or annoying to consider that when the sequester was conceived in August 2011 during the debt ceiling negotiations, it was thought to be a deterrent -- a plan so absurd and dangerous that it would force both sides to come to the table. Obviously there is nothing too absurd for politicians.

Meanwhile, sequestration has become accepted as a fait accompli among investors, who have built in the ensuing slowdown into their 2013 forecasts. The economy is expected to sputter along at about 2 percent annualized growth, which nearly matches the pace seen in the last two years. But it was not sequestration that caused the first signs of anxiety in markets last week.

The stated cause of the Wednesday-Thursday sell-off was the release of minutes from the Fed's January policy meeting. At that central bank confab, "many" of the 19 officials who attended the meeting "expressed some concerns about potential costs and risks arising from asset purchases." Some investors read the concerns as a sign that that the Fed's bond buying might end sooner than expected. Others scoffed, noting that Fed Chairman Ben Bernanke and his cohorts have repeatedly said that low rates and bond buying will remain in place until unemployment drops to at least 6.5 percent. They attributed the selling to profit taking after 7 consecutive weeks of gains.

Congressional leaders will ask Bernanke about the Fed's commitment to its policies when he testifies before the Senate Banking and House Financial Services Committees for his semi-annual Humphrey-Hawkins testimony this week. Chief among the concerns of lawmakers will be the possibility of future inflation and how the Fed will eventually unload trillions of dollars worth of bonds from its balance sheet without disrupting fixed income markets or taking big losses on securities purchased at higher prices.

Markets:

After reaching five-year highs on Tuesday, stocks ended the week lower. Helping the bull case has been a better than expected earnings season. According to Yardeni Research, nearly 80 percent of S&P 500 companies have reported results and earnings for these companies are up 7 percent year over year on sales growth of 1 percent. Perhaps of greater importance, 70 percent of the companies exceeded industry analysts' earnings estimates.

-- DJIA: 14,000 up 0.1 percent on week, up 6.8 percent on year

-- S&P 500: 1,515, down 0.3 percent on week, up 6.4 percent on year

-- NASDAQ: 3,161, down 0.9 percent on week, up 4.7 percent on year

-- April Crude Oil: $93.13, down 3.4 percent on week

-- April Gold: $1,572.80, down 2.2 percent on week

-- AAA national average price for gallon of regular gas: $3.78 (up $0.46 from a month ago)

THE WEEK AHEAD:

Mon 2/25:

8:30 Chicago Fed Activity

10:30 Dallas Fed Manufacturing

Tues 2/26:

9:00 FHFA House Price Index

9:00 Case-Shiller Home Price Indexes

10:00 Bernanke semi-annual Humphrey-Hawkins testimony before Senate Banking Committee

10:00 Consumer Confidence

10:00 Richmond Fed Manufacturing

Weds 2/27:

8:30 Durable Goods Orders

10:00 Bernanke semi-annual Humphrey-Hawkins testimony before House Financial Services Committee

10:00 Pending Home Sales

Thurs 2/28:

8:30 Weekly Claims

8:30 GDP 2nd revision (Q4 initial: -0.1%)

9:45 Chicago Purchasing Managers Index

Fri 3/1: SEQUESTRATION

Motor Vehicle Sales

8:30 Personal Income and Spending

9:55 Consumer Sentiment

10:00 ISM Manufacturing Index

10:00 Construction Spending