The Week In The US: All We Want For Christmas Is A Deal
BNP Paribas | Dec 23, 2012 05:33AM ET
Averting the fiscal cliff is the single element that will save the US economy from a renewed recession, which would have terrible effects on the labour market, with no possibility for the Fed to even partly offset the drag.
To that matter, the news flow turned positive this week, as President Obama and Speaker (of the House of Representatives) Boehner are getting closer to a deal. Details are still to be spelled out, but it appears that the top marginal rate of the Federal income tax would be allowed to move back to its pre-Bush-tax-cuts level of 39.6% (currently 35%).
The level of income that would be taxed at this top rate is still to be decided. The preliminary request from President Obama was for annual income of more than $250,000. Republicans were asking for a higher level of $1,000,000. The deal is likely to set the limit between $500,000 and $750,000.
On the spending side, President Obama is asking for all sequestrations (automatic cuts in spending, part of the August 2011 law that allowed the federal debt ceiling to be raised) to be cancelled. Still, cuts in spending would be implemented, but on a more spread-out and balance way, while President Obama is said to have made a move on mandatory programmes. Specifically, the indexation of certain federal benefits would be changed, allowing them to grow more slowly in the future, and saving around $200bn of federal money.
The deal is said to be close to the necessary $4tr savings over 10-year. However, from the very little few details available, we’re having problems to get to such a big number: around $1tr of additional revenues and $1tr of spending cuts do not add up to $4tr. Even if adding $800bn of savings from ending military operations in Afghanistan and Iraq and $200bn in savings thanks to less generous increases in pensions, we still come short of the magic number by about $1tr.
Whatever the number, whatever the details, the fiscal cliff looks like it will be avoided. But you would better refrain yourself from over-optimism, as an agreement between President Obama and Speaker Boehner is just a first step, even if in the right direction. The piece of legislation still has to be passed by Congress, and even if the weight of tea-partiers is lighter than it used to be, tax hikes may still prove difficult to swallow for some Republicans.
We are cautiously optimistic that a law will be passed, allowing to lift a brake on the US recovery. Federal fiscal policy will still be less expansionary in 2013 than in 2012, but the constraints on State and local governments’ finances are also easing, which should allow their fiscal policy to get less of a weight. With a smoothed adjustment of public finances over the medium-term, the fiscal outlook will be cleared, allowing consumers and firms to go back to business as usual.
If well designed, the deal is likely to come with a rebound in business investments and job creations that should allow a self-sustained recovery, gaining momentum over the course of the year.
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The end of the world is to be avoided (we’ll have to wait until the 22nd of December to be definitive about that…). The perfect scenario we just described is not for sure, though. Consumers are still repairing their balance sheets, which will cap the growth in their spending. For the business sector to expand capacity productions again, if the US part of their demand is lacking strength, foreign demand will have to grow even faster.
If recent data are quite positive from China, other large emerging economies are struggling. In the eurozone, prospects are getting slightly more positive, but the improvement is more marked for Germany, which is more a competitor than a customer for US firms.
In all likelihood, US activity is set to record a limited recovery in 2013. Additionally, it could be bumpy. The last months of 2012 saw households and firms slowing down on spending in the run up to the fiscal cliff. In early 2013, a lot of previously postponed expenditures are thus likely to occur, pushing up the rate of growth. We will have to be cautious not to expect the expected acceleration in Q1 2013 to persist.
As for monetary policy, there is no ambiguity. It will remain accommodative for long. With the new commitment to keep interest rates close to zero as long as the unemployment rate is higher than 6.5%, any marked acceleration in monthly job creations could however lead financial markets to expect the normalisation to come sooner than in 2015. Since the Fed also committed itself to buying Treasuries as long as needed, the chance for yields to increase are however limited. For now…
By Alexandra ESTIOT
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