Tuesday, November 27, 2012

Fiscal cliff negotiations begin in earnest

Fiscal cliff negotiations have begun in earnest.  I remain of the view that the there will be a positive outcome.  Remember “positive” in this context means fiscal policy will be more contractionary next year than this, but not to the full extent the cliff would suggest.
The good news is that US underlying economic fundamentals continue to improve.  Recent housing market and manufacturing data continue to turn up, and that’s even in the aftermath of super-storm Sandy.  Also initial jobless claims are heading back down from their Sandy-induced spike higher.
Furthermore, market expectation is that US third quarter GDP will be bumped up from an initially report seasonally adjusted annual rate (saar) of 2.0% to around 3.0% when the first revision is released this week. That means the slowdown we expect to see in the current fourth quarter will be coming off a higher base.
We know that firms have been delaying hiring and investment decisions in the face of fiscal uncertainty.  As the fiscal murk clears we expect to see a bit of catch-up activity on both fronts which we expect to flow through into the number in the first half of next year.
That means a higher level of fiscal contraction will be happening at a time when underlying fundamentals are improving.  The organic recovery we are seeing in the US housing market is especially pleasing in that regard.  Another positive, or at least non-negative, is that the drag on GDP growth from US state and local Government appears to be diminishing.  That’s a good thing as Federal austerity steps up a notch.
Despite our expectations of an eventual positive outcome the next month of negotiations will not go smoothly.  Sure President Obama has a fresh mandate and the GOPs have no moral authority to assert their programme on an electorate that chose the other team, but neither will they cave in on their principles.  Be prepared for a bumpy ride.