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Title: November Market Review

Subtitle:  Focus shifts back to the economy as the fiscal cliff looms

 

After a tense October when all eyes were on the US presidential election, markets are gradually shifting their focus back to the economy. Standing in the middle of the road is the “fiscal cliff,” a massive series of spending cuts and tax increases that Congress voted would come into effect on January 1rst, 2013, if Republicans and Democrats fail to come up with a debt reduction deal before then. The good news is that Washington is beset with a conciliatory mood, so an agreement of some sort is likely. However there may well be tense moments between now and then.

 

The fiscal cliff measures, if enacted, would remove an estimated $560 billion in stimulus from the US economy next year (about 4% of gross domestic product) and would almost certainly throw the country into recession. Former US Treasury Secretary Larry Summers has said that hitting the cliff would “catastrophic.”

 

The stakes are significant. The United States continues to have world’s largest and most influential economy. And despite its recent sluggishness, the effects of what happens there would quickly spill over into Canada (as Finance Minister Jim Flaherty recently acknowledged) and the rest of the world.

 

As a result, all eyes will be on Washington during the coming weeks. Post-election, power is split roughly as it was before, with Republicans controlling the House of Representatives and Democrats holding both the White House and a slim majority in the Senate. However the new crop of elected officials will only take power when the President is sworn in, in early January. As a result, it will up to the existing lame duck session to find a way out of this mess before the deadline hits.

 

At first glance this would signal continued gridlock. However, with little incentive left to hamper President Barack Obama’s progress (after all he is not running for reelection again) Republican leaders have been making increasingly conciliatory statements indicating a possible compromise.

 

That’s important because any deal would include both spending cuts and tax increases, both of which could hurt consumer demand and thus business sales, profits and eventually stock prices. On the other hand, if the deal is credible, it could set the stage for a long-term recovery.

 

Another bone of contention during coming weeks relates to the US government borrowing which is one again nearing its latest debt ceiling limit: $16.4 trillion set in January of this year following tense negotiations.

 

In fact acrimony at the time was so vile, that the Standard and Poor’s rating agency cited the gridlock as one of the key reasons for its downgrade of US debt (from AAA to AA+). The other two major rating agencies (Moody’s and Fitch, both of which continue to maintain their AAA ratings) will no doubt be closely watching the upcoming bartering to see if they too will act.

 

That said, despite the bluster in Washington, few economists believe that the fiscal cliff will ever be hit. At worst, politicians are expected to negotiate temporary measures to kick the can down the road, at which time a more permanent deal could be arranged.

 

 

peter@peterdiekmeyer.com

 

 

 

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