US fiscal cliff – a short-term fix

In the last two days both the Senate and the House of Representatives have voted to pass the most recent bill, ‘The American Taxpayer Relief Act’, to avert the so-called ‘fiscal cliff’.  The outcome is pretty much what we expected, a publicly fought battle that went down to the last possible moment with the fiscal policy drag in 2013 ultimately reduced from about 4% of gross domestic product (GDP) to a more manageable 1% or so.  On balance, there was less reduction in proposed spending and more emphasis on tax increases than we might have forecast.

The political deal does not solve longer-term fiscal issues in the US, and does not do enough to avert the need for a vote in the next couple of months on an increase in the government debt ceiling. This deal should not, therefore, be regarded as a long-term ‘grand bargain’ – merely as a single round in a longer political fight that will continue for years to come.

We believe that a 1% drag on GDP from fiscal policy is something that the US economic recovery is robust enough to handle, and that the growth that was evident in 2012 will continue as important areas of the economy, including housing and autos, sustain their recovery. For now, this political deal should enable financial markets to avert their gaze from the political battleground that is Washington DC and refocus on the improving economic data from the US and other regions of the world.