26 Dec 2012
December 26, 2012

What If We Do Go Off The Cliff?

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 Will the economic stress be as severe as many assume?  

What are the chances of a fiscal cliff deal? Every day seems to bring a new assessment from the media. As Christmas approaches, little progress has been made and the Senate is poised for a holiday recess ending December 27. If a deal isn’t reached, what might result for the economy and the markets?1 

What’s the worst that could happen? For that scenario, we might as well check in with “Dr. Doom.” That is the nickname for Nouriel Roubini, the economist who famously predicted the 2008 Wall Street downturn. Earlier this month, Roubini told Bloomberg TV that “there’s a highly likely chance we’re going to go over the cliff.” Come January, “the market reaction is going to force the two sides to reach an agreement.” Roubini thinks that even with an agreement, our 2013 GDP will be about 1.7%. On a positive note, he feels that “the [long-term] fundamentals of the U.S. are a lot stronger” than those of other key world economies.2

Roubini’s forecast is far from the worst out there. In its gloomiest scenario, UBS sees a 2% contraction in GDP for the first half of 2013 with the S&P 500 trading at 1,000-1,100, demand for the dollar soaring, and prices of metals and energy futures sinking. Morgan Stanley thinks there could be as much as a 5% hit to GDP given that the payroll tax holiday will also likely expire; Bank of America sees anywhere from a 2.5%-4.6% impact on 2013 GDP, with a multi-stage fix for the problem on Capitol Hill wrapping up by April. The Congressional Budget Office’s worst-case scenario includes a recession and 9.1% unemployment.3

Could we merely see a fiscal slope, or a fiscal pothole? If a deal is deferred until late January, the economic impact might not be as bad as feared. Congress could end up retroactively preserving the Bush-era tax cuts for most Americans, and the tax increases resulting from the cliff could be struck down.

Here’s why it looks like a slope rather than a cliff: the so-called sequester (the $1.2 trillion in planned federal spending cuts) will occur gradually over the next decade rather than instantaneously. If no deal occurs, next year’s across-the-board federal spending cuts will total only $109 billion, and they could even be smaller if Congress hastily opts for a package of selective cuts rather than a real fix; one proposal circulating around Capitol Hill this fall only called for slashing $55 billion in 2013, according to Reuters.4 

In the fiscal pothole scenario offered by analysts at UBS, small concessions are made on Capitol Hill as 2012 ends (i.e., the payroll tax holiday and long-term jobless benefits expire while taxes increase temporarily), pursuant to a “grand bargain” in 2013 that cuts at least $4 trillion off the deficit in ten years.3

What sector would be hit hardest if there is no deal? As an article at TheStreet.com mentions, the consumer discretionary sector may be significantly impacted without a fiscal cliff fix for 2013. The automotive, apparel and entertainment industries in particular might see waning consumer demand.5 

If the economy does fall off the cliff, the effect will probably be felt gradually by businesses large and small. The sudden shock may occur on Wall Street, which in the glass-half-full scenario prices the fall in without bulls fully retreating.

Now is a good time to evaluate your options in case a deal doesn’t happen in Washington. A talk with a financial services professional could give you more insight into the choices you have for 2013.

Citations.

  1. news.yahoo.com/reid-u-senate-return-dec-27-no-pre-180003533–business.html [12/20/12]
  2. blogs.marketwatch.com/thetell/2012/12/14/u-s-will-go-over-the-fiscal-cliff-and-markets-will-force-a-deal-nouriel-dr-doom-roubini/ [11/14/12
  3. www.businessinsider.com/fiscal-cliff-worst-case-scenario-2012-11?op=1 [12/13/12]
  4. www.reuters.com/article/2012/10/22/us-usa-congress-fiscalcliff-idUSBRE89L0YB20121022 [10/22/12]
  5. business-news.thestreet.com/thestreet/story/3-hardest-hit-industries-if-us-goes-off-fiscal-cliff/11797229 [12/20/12]