How close is Washington from a fiscal cliff?

After months focused on the eurodrama, markets are starting to care more about the so-called fiscal cliff, a popular shorthand term used to describe the situation that Washington will face at the end of this year. Bush tax cuts are set to expire unless Republicans and Democrats agree on how to extend them and who would have to pay. This combined with $110 billion in defense and domestic spending cuts set to kick in could lead to a fiscal meltdown that will affect millions of American taxpayers.

According to JP Morgan Spain, this economic disaster has a 15 percent chance of happening.

“Whatever the election results may be, our analysts give the US a 15 percent chance of going down the fiscal cliff in the first six months of 2013”, the financial services firm says in a report.

The worst moment will be when lawmakers may have to vote in order to raise the debt ceiling at some point in 1Q13. This will inevitably lead to a political brink, says JP Morgan.

EFFECT IN THE US TREASURY

For every dollar they get from fiscal tightening is a dollar less the U.S. Treasury needs to issue. But more importantly than that to the behavior of bonds will be the economic growth prospects. Every 1% GDP increase in growth prospects results in a in a yield 20pb over the 10yr UST. Inflation expectations are also important but half less of how growth expectations do.  The evolution of the risk premium may be responsible for 2/3 parts of the volatility that may have the UST”.

The US has been delaying tough decisions on fiscal tightening for a long time. As a result, the snowball has got huge proportions by now. For JP Morgan, there might be a point when last summer’s uncertainty can seem a children’s game compared to what can really happen.

Consumer decisions and companies are already being affected. Nearly one in five fund managers view the US fiscal cliff as a greater cause for alarm than the eurozone crisis, according to the latest BofA Merrill Lynch fund manager survey.

About the Author

Ana Fuentes
Ana Fuentes is The Corner Editor-in-Chief. Currently based in Madrid, she has been a correspondent in New York, Beijing and Paris for several international media outlets such as Prisa Radio, Radio Netherlands or CNN en español. Ana holds a degree in Journalism from the Complutense University in Madrid and the Sorbonne University in Paris, and a Masters in Journalism from Spanish newspaper El País. You can contact her at: anaf[at]thecorner.eu

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