Fiscal Cliff Loose Ends

Via Citi’s Steven Englander,

The fiscal cliff deal appears to be a done deal and markets have reacted accordingly (although President Obama is apparently awaiting a photo-op later today to sign it). However, the deal leaves a large number of loose ends that ensure high drama for the next two months on the US fiscal front. The immediate impact of all the loose ends and deadlines may be smaller than the Dec 31 fiscal cliff, but all of these loose ends are important and could lead to short-term price action. Several of them are very important for the long run USD outlook as well.

Loose end number 1, at least chronologically, is the political futures of Mrs. Boehner, Reid and Geithner. Treasury Secretary Geithner previously indicated he wanted to stay until the end of the year to try and get a budget deal done. The legislation passed by the House and Senate might be considered a half deal, but is this the point that Geithner walks away? I would presume that he does, although he may choose to stay until the end of March. He has not said anything on that issue for over a month. It is likely that President Obama will announce new cabinet appointments in one big announcement at some point over the next two weeks. House Speaker Boehner and Senate Majority leader Reid will be up for vote on their continuing leadership tomorrow, Jan 3. Congress convenes. Boehner is the most likely to face a challenge, perhaps from his deputy, House Majority leader Eric Cantor of Virginia, who voted against the Senate bill. The other potential challenger, Paul Ryan, voted for the bill. At this stage it is unclear whether either will challenge speaker Boehner. It appears unlikely that anyone would challenge Senator Reid as the leader of the Democrats in the House, although his ‘brand’ seems diminished by the fact that Vice President Biden took over negotiating the Democratic side from him and got a deal done.

The next loose end, chronologically, is probably the new sequester deadline of March 1. Previously agreed spending cuts will kick in on that date unless they are kicked down the road again. Kicking them down the road in a smaller bill may be difficult, though, because without offsetting provisions, the bill will score as being expensive. If all the sequesters are permanently averted, the cost is USD1.2trn over ten years. After the March 1 deadline, there is one additional minor sequester-linked deadline. On March 27 Congress must agree on what it is going to do to make up for overspending since the first sequester, likely to amount to about USD15-20bn.

From what Geithner and the Treasury have said in public pronouncements, the US will bump up against the debt ceiling at some point around March 1. If tax collections are high in Q1 then the debt ceiling breach could be avoided for another 2-4 weeks, but it appears unlikely that the debt ceiling could be pushed beyond the end of March. On March 30 Congress must pass a budget or otherwise extend spending authority. This deadline results from Congress not having passed a budget for the fiscal year that begins in October. Without spending authority, the Executive Branch would in theory be forced to shut down the government.

Although it doesn’t necessarily come with a deadline, another loose end from lawmakers is corporate tax reform. Both Republicans and Democrats have said repeatedly over the past year that it is a priority. In his speech promoting the latest compromise, Obama talked about doing a ‘grand bargain’ in pieces and talked about wanting another revenue increase to offset any additional spending cuts. Presumably the revenue piece is corporate tax reform, although the corporate tax reform Republicans are talking about is a ‘territorial’ system with lower marginal tax rates. This issue is likely to bring a major clash, that could occur in February and March or could conceivably be delayed. It is arguably the most critical issue for the USD in the long run. Existing tax law incentivizes US-based multinationals to produce and book profits abroad. Alterations to the law, depending how they shake out, could lead to greater incentives to produce in the US and therefore a smaller trade deficit and/or a wall of repatriation like the one that occurred during the HIA amnesty period in 2005. If something remarkable happens on this issue then we would have to immediately re-examine a bearish USD view for 2013, but if there is no major reform, the likelihood of a ‘structural’ USD rally is low.

There is one final loose end, and that is the ratings agency response. Ratings agencies were fairly consistent in saying that a ‘grand bargain’ deficit reduction plan that would take 2.5trn or more off the ten-year deficit would be required to avert a US sovereign downgrade. With the US having failed on a one-stage grand bargain, it is unclear whether a downgrade would come in the next few days. Ratings agencies may choose to wait to see what happens in March with sequesters, the debt ceiling, etc.

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