Preparing for the US ‘fiscal cliff’
Combination of spending cuts and tax rises could kill recovery
Investors face a dilemma over the US economy. If positive signs among consumers and in the housing market are to be believed, strength in the US could help restore confidence in the global economy.
However, political squabbling in the run-up to the forthcoming presidential election in November and the so-called ‘fiscal cliff’ in January – expiring tax cuts, automatic spending cuts and fiscal tightening worth roughly $700bn (£450bn) or 4.6 per cent of GDP – may forestall recovery.
The focus on the US economy comes at a time of increasing pessimism over the state of the eurozone economy – and a dangerous lack of political solutions – as well as indications of slowing growth in China.
Barings believes that a combination of policy stalemate in Europe and Chinese inertia mean there is an increased chance of the global economy slipping into recession in 2013, though a more positive contribution from a healthier US economy could help avoid this outcome. We have recently moved the allocation of our multi-asset portfolios towards more defensive asset classes. We reduced our equity holdings from 50 per cent at the start of the second quarter to roughly 30 per cent today and increased allocations to cash and developed government bonds. We are concerned that even if the underlying trend in the US is one of reasonable growth, the second half of the year could be damaged by the perception that the proposed public sector spending cuts after the presidential election could derail the economy. The prevailing consensus is that Congress will act early in 2013 to forge a new compromise involving only moderate fiscal tightening.
However, with the election campaign likely to get nasty, an early agreement might be wishful thinking. Even if this does materialise, US businesses may adopt a ‘wait and see’ approach and postpone recruitment and capital spending, although this may be offset somewhat if individuals choose to bring forward capital gains and dividends in anticipation of higher taxes.
A ‘wait and see’ approach has the potential to slow growth by up to 1 per cent of GDP. Republicans and Democrats are approaching the elections at odds over the solution to the fiscal gridlock, with no obvious deal in sight. While consumer, business and market confidence could be dented in the short term, it is expected to recover in the long term as we predict the proposed plans will be scrapped.
Positive signs are emerging from the US automobile and housing markets. The automobile market has improved after the ‘cash for clunkers’ drive in 2009. More significantly, after bottoming out in 2008, the US housing market is recovering. States such as Florida, Las Vegas and California have cleared their backlog of repossessed properties while residential rental yields have become an attractive option. US residential building permit levels have risen 7.9 per cent to their highest level since September 2008. A recovery in housing is not certain, but it could add up to 1 per cent to US GDP.