A Year in Review – 1 – Hiking Up the Fiscal Cliff
The year-long climb up to the fiscal cliff has led to prolonged uncertainty for markets and with less than three weeks to go, there’s no guarantee this will change in the year ahead.
If a deal is not agreed to force a compromise on the Federal Budget and the debt ceiling, the US Budget Control Act of 2011 will come into effect at midnight at the end of month. This will result in massive spending cuts and sweeping tax increases – including the expiration of Bush-era tax cuts and the 2% Social Security payroll tax cut.
However with no one moving in to defuse this ticking -time bomb, it looks as though the US is likely to fall off the Fiscal Cliff and land head first into recession in 2013.
I for one didn’t expect negotiations to begin in earnest before the federal election, but with the re-election of President Obama on November 6th, the pressure was immediately ratcheted up on the negotiations. While the real economic pain will be felt in 2013 if a deal is not reached, current markets are facing speculation on both sides due to the see-sawing of negotiations.
To deal or not to deal – What’s the Market Impact
If a short-term deal is struck to avoid the fiscal cliff, leaving tougher decisions to be made further down the line about the deficit and spending, safe-haven commodities such as gold could rise as investors try to avoid the risk created by not dealing with these key issues.
If no deal is struck at all, then commodities in general will be hurt by the subsequent economic collapse.
In the case of oil, there is substantial uncertainty on future demand. Cuts to the military included in the Fiscal Cliff legislation could severely depress demand in 2013 if a solution is not found. On the other hand, if a meaningful long-term deal is reached, it could help to improve the economic outlook in the US and could even create an increase in demand.
Back to the present, and a lack of confidence in negotiations has already caused an increase in short-term investments that has driven Treasury yields to a 2-month low. We’ve also seen companies issuing early dividends to their shareholders to avoid the expiration of the Bush-era tax cuts which limited the tax rates on dividends to 15%.
While these reactions are mainly due to fear of the Fiscal Cliff, the uncertainty of what measures could be included if a deal is struck has probably also played a role in these decisions. A perfect example of this is the stalling of wind power expansion due to the indecision of whether their production tax credits will be renewed in 2013.
The Global Ripple Effect
While the Fiscal Cliff is an issue that can only be resolved by the US government, the repercussions of it will ripple around the globe. Forecasts of an imminent economic collapse in Europe have resided in recent months. However the threat remains. With continued economic contraction in Europe, the US driving over the fiscal cliff could have serious consequences for the EU in the coming year.
Sadly, this will probably not be the last we hear of the Fiscal Cliff. I’m already reading articles about the Fiscal ‘Grand Canyon’ made up of the $65 trillion dollars’ worth of unfunded liabilities in the coming decades. I had hoped that hyperbolic descriptions of financial crises would be a fad of only 2012. However, the fact remains that the US will face further precipices on its return to economic growth and security.
Understanding and evaluating risk in the global economy is becoming an ever more difficult task. Massive deficits and debt loads in developed economies are a problem that needs to be tackled around the world and the fiscal cliff is a significant test as to whether governments have the will to deal with these issues head-on.
Regardless of the outcome, investors are faced with risk from more sources than ever and must outfit themselves with the tools required to make informed decisions in these uncertain times. These decisions need to happen in a timely and informed manner and ZEMA is a best-in-class data management tool designed to make sure that you get the detailed data you need to make them.