The Fiscal Policy Q&A, Timeline, And Market Scenarios

Tyler Durden's picture

Talks on the fiscal cliff have resumed, but as of this writing there is not yet an agreement. The current negotiations focus on the income threshold under which tax cuts should be extended, among other topics. As we have noted, the sides seem as far apart as ever, and as Goldman notes, while it is still possible that an agreement will be reached by year end, a retroactive deal in January looks more likely. The eventual resolution still looks likely to be a scaled down agreement that addresses only the policy changes scheduled for year-end and omits other issues, such as an increase in the debt limit or longer-term fiscal reforms. The greatest area of uncertainty is whether the spending cuts scheduled under the sequester will be addressed. The fiscal policy timeline below shows how we are rapidly approaching the more ominous debt ceiling debate and Goldman's Q&A asks and answers provides context for where we are from both an economic and ratings agency impact basis.

Scenario Analysis (Via Citi's Steven Englander):

The most likely FX/fiscal cliff outcome is a combination of limited fiscal progress and very easy money that will likely be USD negative. This may be why the S&P sell-off has generated limited USD weakness so far:


Expectations for fiscal cliff outcome are converging on one of three scenarios, each of which has strong USD-negative implications:

  1. a nasty, brutish and small fix by midnight December 31st;
  2. a quick drop over the cliff that gets resolved before this Congress ends at noon January 3
  3. the new Congress manages to pass an even more limited fix early in its session.

The fiscal outcome of each of these is likely to contain very limited long-term deficit reduction and expenditure control, but enough short term fiscal restraint to keep the Fed oriented to its very easy money policy orientation. It is also likely to lead to a US credit downgrade.  This combination of outcomes will not be risk-off enough to generate safe-haven USD buying, will raise concerns over long term US fiscal sustainability as well as the political ability to deal with the fiscal imbalance, and stoke expectations that Fed ease will be with us for a long time.


With S&P futures closing at 1384 it has now retraced about 2/3rds of the way back from its post-election 1441 peak to its 1344 November 15 trough. However, even on November 15, investors were far from pricing in certainty of a hard fall over the fiscal cliff, so it remains the case that we would get a much bigger drop if there such a hard fall over the cliff emerged. When the S&P was at its early-June low of 1278, CAD was at 1.04, AUD at 0.97 and MXN at 13.75, and it still remains very likely  that further significant S&P weakness would bring more pressure on these risk-correlated currencies than we have seen so far.


If I am correct above, investors are still pricing in a moderate recovery, easy money and ongoing political confusion – a hard fall over the cliff would quickly shift this scenario to outright panic and this would be much more positive for the USD than anything we have seen recently.

Q&A and Timeline (Via Goldman Sachs):

Q: Where do things stand now?

A: Talks have resumed, but as of this writing there is no agreement yet. President Obama and congressional leaders met this afternoon to discuss the possible next steps that might be taken to avoid the fiscal restraint set to take effect at year-end. It seems likely that Senate Majority Leader Reid (D-NV) will bring up legislation on the Senate floor at some point before the end of the year, but it is not yet clear whether that will be the product of a bipartisan compromise reached with Republican leaders and the President, which would have a chance of passing both chambers of Congress, or a proposal supported only by Democrats, which would be less likely to pass in either chamber, particularly the House.

Q: Will there be an agreement by year-end?

A: It is still possible but a retroactive deal in January looks more likely. With little time left before year end, there are two obvious obstacles to enacting an agreement by that time: the lack of a political agreement, and the short time left on the calendar to get any agreement that might be reached enacted into law. Reaching a political agreement is the tougher part. It is conceivable that Senate Republicans could allow a compromise dealing with the middle-income tax cuts and a few other items to pass in the Senate; this would happen if Republicans refrained from objecting to consideration of a bill, allowing it to pass with a simple majority (i.e., most of the 53 Senate Democrats) rather than the 60-vote supermajority that has become customary for major legislation.

However, House Speaker Boehner has stated that he will not support a plan that involves passing legislation in the House with mostly Democratic votes. This may become less of a constraint after year end, since (1) taxes will have risen, allowing both parties to claim that the agreement is a “tax cut,” (2) the House will vote to choose its speaker January 3, after which it may be easier for Speaker Boehner to allow legislation to pass with mostly Democratic votes, and (3) public pressure on lawmakers will have increased, making them more willing to compromise.

In the somewhat less likely event that an agreement is reached before year-end, the logistics of passing it in the House and Senate will take a bit more time, but will be less relevant. Most market participants and the broader public are likely to respond more to the news of an agreement rather than the particulars of the legislative process that follows. Second, while passage using normal legislative procedures could take over one week, passage could be accomplished in just a few days if there is political will to do so.

Q: If an agreement is reached, what would it look like?

A: Probably a scaled-down deal. At this point, the most likely solution prior to year end (or in the first few days of 2013) would be enactment of a scaled-down agreement that addresses only the policy changes scheduled for year-end and leaves for later other issues, such as an increase in the debt limit or longer-term fiscal reforms. This might involve an extension of the 2001/2003 tax cuts for income under $400,000 or $500,000 (including capital gains and dividend tax rates at 15% for taxpayers with income under that level and a 20% rate above), relief from the alternative minimum tax (AMT) for 2012, and extension of emergency unemployment benefits, which are scheduled to expire at year end.

A few other aspects of a scaled-down agreement are less clear:

  1. A debt limit increase looks likely to be omitted from a scaled back agreement. The President did not include a debt limit increase in the scaled-down approach to the fiscal cliff he announced on Dec. 21, nor in the proposal reported today.
  2. It is unclear whether such a deal will fully address the sequester. It is possible that a compromise could delay the sequester for a short period (i.e., 60 or 90 days), or that it could delay only part of the spending cuts that are scheduled to take effect (i.e., only the defense portion). It is possible, but less likely, that a last-minute agreement could simply not address the sequester at all, leaving the issue to be dealt with in early 2013.



Q: If there is no deal by year end, does it matter?

A: Yes, but how much will depend on how uncertain the outcome remains, and how long the uncertainty lasts. In our view it seems more likely that Congress will miss the year-end deadline but will pass an agreement in January. In theory this could come as early as January 2, the last day before Congress convenes for its new session, but it seems more likely to occur between January 3 (the first day of the new session and the scheduled date for congressional leadership elections) and January 21, when the President will be inaugurated into his second term (Exhibit 1 lists key fiscal policy events over the coming months).

The effect of a temporary lapse would come mainly through confidence. We have noted recently that policy uncertainty might hold back capital spending. The risks associated with the fiscal cliff also seem likely to have already weighed on consumer confidence to some extent, even before the deadline. Consumers’ assessment of the current situation has become quite positive at the same time that their expectations for the future have become more pessimistic (Exhibit 2). This is likely due in part to reduced expectations of a deal by year-end; indeed, internet searches for the term “fiscal cliff” have outpaced searches related to the debt ceiling at the comparable period in 2011. (Exhibit 3). However, from a fundamental perspective, the effect of a short lapse would probably not be that significant, assuming that it lasted no more than a few weeks. This would be especially true if there is some certainty regarding the eventual outcome, and an expectation that the eventual agreement will be made retroactive (which we expect it would be).



Q: Is there anything that can be done to avoid the increase in tax withholding and decrease in spending set to take effect that doesn’t involve Congressional approval?

A: The administration can prevent some of the tax increase and sequester, but only for a while. The Internal Revenue Service (IRS) must decide how to instruct employers and payroll processors to withhold taxes from paychecks starting January 1. Normally the IRS transmits updated withholding information by early December to allow sufficient time for systems adjustments. While the IRS has indicated it will provide guidance by year end on appropriate withholding for 2013, to date it has not provided an update. While some larger payroll processing firms and employers may be able to adjust systems very quickly in
response to a last-minute deal, smaller firms may not be able to adjust as quickly.

The IRS also has discretion in how much to instruct employers to withhold. Although only Congress determines the ultimate tax liabilities individuals will face for 2013, the IRS must instruct employers on how to best withhold taxes from paychecks to match those rates. In principle, the IRS could simply instruct employers to leave withholding unchanged until an agreement is sorted out, at which point new withholding instructions could be transmitted. This is an obvious short-term solution, but it could only be used for a few weeks. If the IRS declined to update withholding instructions much longer than that, individuals could face a more serious gap between their withheld taxes and ultimate tax liabilities, resulting in significant tax liabilities at year end, or an even sharper increase in tax withholding once instructions to employers were eventually updated.

On the spending side, the administration can delay the spending cuts scheduled to take effect under sequestration if a deal seems close at hand.1 However, just like a delay in the scheduled tax increase, failure to implement the cut at year end might mean an even sharper adjustment later if Congress is unable to reach an eventual agreement, since the required reduction would need to be concentrated in a shorter period (i.e., the remainder of the fiscal year that ends September 30, 2013).

Q: The debt limit will be reached December 31?how does this relate to the "fiscal cliff"?

A: The debt limit is separate from the fiscal cliff, but intertwined in the negotiations. The Treasury projects that the debt limit will be reached December 31, but that it will be able to tap certain funds that will allow it to continue to borrow as necessary until late February 2013, by which point Congress will need to increase the limit. The Treasury notes that if the fiscal cliff is left unresolved, the deadline for the next increase in the debt limit would be pushed beyond late February, though it does not specify how far beyond. Exhibit 4 shows our projection of debt subject to limit under our base case fiscal assumptions and a scenario in which the fiscal cliff is not resolved.

The White House very much wants to avoid another disruptive debate over the debt limit similar to the one that occurred in the summer of 2011. The Administration had hoped to include a debt limit increase in the year-end agreement, first proposing an open-ended increase, and later seeking a two-year extension. However, congressional Republicans continue to insist on a dollar of spending cuts (measured over ten years) for each dollar the debt limit is increased. At this point it appears more likely that the debt limit increase will be left out of a year-end deal, as will any long-term spending reforms. Instead, these look likely to be debated in a second round of negotiations ahead of the next deadline, probably in February 2013.


Q: What should we expect from the rating agencies?

A: Probably no action as a result of the fiscal cliff, but a downgrade in 2013 is possible. Two of the three major rating agencies, Standard & Poor’s and Moody’s Investor Service, have indicated they are unlikely to lower their rating regardless of how the fiscal cliff is resolved. While both acknowledge that a sharp fiscal contraction would lead to economic uncertainty and a likely recession, the contraction would also probably be enough to stabilize and slightly lower the debt-to-GDP ratio over the medium term, which is the most important criterion for the sovereign rating. By contrast, Fitch Ratings, which maintained a stable outlook on its AAA rating longer than the others (it shifted to a negative outlook only after the “super committee” failed to reach an agreement in late 2011) has become more downbeat, suggesting a downgrade is possible if the debt limit is not raised in a timely manner or if the fiscal cliff is allowed to take effect for long enough to have significant economic effects.


Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
ebworthen's picture

Whatever the clown politicians do or don't do it's a shit sandwich.

ZippyBananaPants's picture

Who gives a crap about all this?  I want to know why the mightyAtlanta Falcons lost to the crappy Tampa Bay Bumblers, and royally screwed up my last chance to win our weekly football pool?



max2205's picture can a deal be made when no budget has been approved for 4 years. There won't be one for the next 4 years

ball-and-chain's picture

It is a shit sandwich.

And we're gonna be forced to eat it for the next decade.

This depression ain't going away.

buzzsaw99's picture

defence, that's a funny way to say it


defund the war machine


fixed it

Atomizer's picture

Hillary will return to work next week, more bread & circus in the makings. A quick relapse will be in order.. However, John Kerry has to be handed the batton.

Banksters's picture

Dear Obammy,


Why you wannna take my guns when you sell weapons to Saudi Arabia, one of the most despotic theocracies around. Man, that is whack.  And that NDAA shit, who tryin to kid, mutherfucka.


FACT, the US sells 78 percent of all arms on the planet.  Note to Feinstein, FUCK YOU.

davidsmith's picture

The fact that the Tea Party Republicans have upped the ante shows that they have the upper hand, and shows that they have formed a hedgehog defense with no defections and no compromises.  That is why these "analyses" above are ridiculous.  The Tea Party House Republicans are an emerging authoritarian regime--they have ONLY the "no compromise" iron in the fire.  If they compromise on the fiscal cliff or the debt ceiling, there is no further reason for them to exist.  They got mauled in the 2012 election, and, like all authoritarian organizations, they are reacting by becoming LESS not MORE cooperative.  It's counterintuitive, but they have calculated that they still have enough power to topple the government.


And they do.  Once over the fiscal cliff, their next tactic will be to say that the debt ceiling cannot be raised before the tax and spend issues are resolved.  Voila!  A constitutional crisis in a few short weeks.  The only way Obama can head them off is to declare a national economic emergency, but he is too weak to do that.  If he does it AFTER a failure to raise the debt ceiling, the Tea Party House Republicans have another readymade argument: dictator.  Obama has broken the Constitution.  Then the political system will break wide open with calls for everything for a tax strike to a general strike, all against a background of rapidly worsening economic conditions.  Our oligarchs can only continue looting now through state-recognized cartels and corporate boards.  They can't get this if the democratic system remains the power regime.


One day we will learn about the secret right-wing meetings after the election which produced this intransigence.  However, it is proceeding perfectly according to the authoritarian playbook: provoking authoritarian rule in order to gain authoritarian rule, clinging to the constitution opportunistically in order to overthrow the constitution, upping the ante whenever it seems a power-sapping compromise might be in view, and above all, gaining power from a WEAKENED, not ENHANCED, position.  There are examples throughout history, from the Directoire all the way to the Bolsheviks. 


Just remember: any compromise by Tea Party House Republicans means the end of the Tea Party.  They would NEVER recover from it.  They have a double whammy golden opportunity now to overthrow the government, with this combination of the fiscal cliff and the debt ceiling. 

Salon's picture

I made it clear to my representative that he better not go back on his no new taxes pledge.

He is a tea partier but has some RINO qualities that make me a little suspicious.

He knows me and knows my threat to challenge him in the republican primaries is not an idle threat.

Hold the line teapartiers. Every time taxes have increased government spending has increased. There is only one way to stop this pattern.

Meatballs's picture

Tea, Schmea. You ain't gonna fix dick.

Salon's picture

I know.

But the fiscal cliff where everyone pays more and most budgets get cut is far preferable to any compromise.

If my taxes go up yours damn well will too

illyia's picture

Hey, political aspirant Salon: If they can make cliff-law retroactive then why can't they make the OBS OTC derivs retroactively illegal. That would make the profits illegal and confiscatible, eh? Banksters would be jailed, and TBTF banks would go belly-up. But the cash-bonuses would be useful, maybe could fund something nice like NEW Banks.

Like a (temporarily) National Bank. It could take the loose change off the desks and drop it into the raided accounts.

Going to happen anyway, with or without guns. And, much less messy.

Meatballs's picture

This tells us exactly what we need to know:


"Negotiations stalled Saturday night when Minority Leader Mitch McConnell pushed a Social Security benefit cut as a way to offset spending measures including emergency unemployment benefits.

Democrats balked, leaked the offer to the media, and Republicans quickly retracted the demand." 


(TPM a few minutes ago)

Jake88's picture

LOL. You made it clear to your representative. When I make my opinion clear to my congressmen they write back telling me what my opinion should be.

Tenshin Headache's picture

They aren't called "Tea Party" for nothing.

realtick's picture

The Tea Party is the only group prepared to politically defend us from total big brother style authoritarianism, and for that we should all be grateful.

Even if a majority of the whole House (Republicans and Democrats) were prepared to swallow the Senate deal, they won't get a chance unless Speaker John Boehner brings it to the floor. And Boehner probably won't. He has adopted a rule that no measure will be voted on unless it is supported by a majority of the majority party — that is, his party, the Republicans. At this point, the Senate deal looks unlikely to appeal to most House Republicans.


Aurora Ex Machina's picture

I'd call a single vision of Religion under God, Christian Fundamentalist style, pretty authoritarian.

Dingleberry's picture

The Repubs have nothing to fear. Does anyone really think they are going to be voted out of Texas, Idaho, n' shit?  I didn't think so.

The MSM is having it's usually "end-of-the-world-Mayan-apocalypse-year-2000-computer-crash"-esque hysteria. For ratings of course.  After all, you have college and pro football playoffs coming. It's gonna take a ton of hype to get the attention of the unwashed. 

Bottom line: the Repubs can do whatever they want. The demographic balance and the 47% ensure another Dem as prez for the foreseeable future.  So why even try and placate the bottom feeders, welfare whores and "disenfranchised"? All politics are local anyways.

pfairley's picture

Demonizing words like this actually show the warlike, authoritarian elements in the left.  Tea party people are not so inhuman. They have legitimate views about 'pay as you go'...having a higher  savings rate...not robbing from our children's future etc.    These are the virtues of WW2 America.....and part  of Krugman's argument that high WW2-like govt debt is actually ok and even good for the economy.....In WW2 personal debt was much lower...savings rate 25%....peacetime govt much smaller and with less legal costs & regulation....Krugman's arguments about hi govt debt being ok don't hold water without more people like in the Tea Party. The weight ot govt jockey riding the economic racehorse cannot be so close to the weight of the horse.

Aurora Ex Machina's picture

I would argue any hedgehog like behaviour is largely due their ideological bias and inability to understand higher-order government or fiscal policy, but hey. As long as you can employ your kids at $200k or so on the gravy train, I'm sure they're in it for the right reasons.

Although, yes. You've a point about The Family, who are still smarting over the beheading of their man Petraeus, but I strongly doubt the new-comer Tea Party members are part of the inner club.


Those ones are more like this

orkneylad's picture

"Oh, man. The bullshit piled up so fast in Vietnam you needed wings to stay above it."

Atomizer's picture

When a political hack is voted into the democratic procedure and fails to represent his constituents. Debt obligation resides on the shoulders of elected individual under the Patriot Act –under fiduciary responsibilities clause. / LOL

rogerthat's picture

what time does market futures start trading?

q99x2's picture

Sounds like in any case they've successfully kicked the can to a field goal.

orkneylad's picture

it's one monster can . . . . do they need toecaps for that?

ReptilianSlaveMaster's picture

Deal or no deal, I voted for Obama cause I am black

I am Jobe's picture

Buy Silver , not the paper shit

Salon's picture

Whats not to like about the fiscal cliff?

10 percent across the board cuts, entitlements excluded. But even the military gets cut.

Everybody pays more in taxes, except the poor.

If this small sacrifice of 0.5 percent of current gdp (as a downpayment on getting our fiscal house in order) is too much to bear, then we really are doomed.

Getting Old Sucks's picture

Feel the same way but OH those DOD contractors will howl!

Getting Old Sucks's picture

It's obvious that they will reach some kind of an agreement to keep things going but anything they do now is (as Bernanke says) transient.  Unfortunately, as Ron Paul said, we are past the point of no return.  They will kick that can down the road for another year or two.  Of course there will be many Senate and Congressional retirements during this time.

devo's picture

Good article.

(So we should buy stocks, right?)

Jake88's picture

yeah back up the truck.

captain_menace's picture

Maybe a stupid question, but here goes...

What does it matter how rating agencies rate the U.S. if the Fed is able to manage (manipulate) interest rates paid by the Treasury on debt?  I thought a particular credit rating was used to determine interest rates paid by the borrower...

Thanks for any clarity.

Getting Old Sucks's picture

I'm probably the least knowledgable to respond to your question, but I think you answered it.

Peachfuzz's picture

Not qualified to answer this, but:

   I suspect the biggest impact of a credit rating downgrade is felt in the derivatives. What happens when these mutual funds and 401ks have to rewrite their bylaws to include the fact that they now hold junk bonds as a "safe as cash" investment?

Not everybody can run to pm's because of the size of the market, so where does all of it go if they can't buy bonds, back into overpriced equities?

AlphaHunter001's picture


LOL the US is far from 'junk' status. As it stands, the US is AAA or one of the strongest ratings in the world. It might be downgraded 1 point


"we'd be looking at a downgrade of a notch to Aa1," said Bart Oosterveld, managing director at Moody's sovereign risk group."


while I do think a pullback is in order for equities, when you consider US companies have never been stronger with record levels of cash and profit margin, it would be hard to find a safer long-term investment. i'd rather own shares of firms with billions in cash and positive cash flow than US debt at 1.7% for 10 years. do you really think MCD or COST is going bankrupt anytime soon? LOL

Insideher Trading's picture

They should extend the calender year past Dec. 31st to Dec. 45th. If we're gona' kick the can let's be unconventional about it.

earleflorida's picture

so a downgrade-- and what dear say does this amorphous animal look like? 

the cost of ink goes up, or my fuel charge increases... inquiring minds want to know!

ItsDanger's picture

Even your chart tells the story of incompetence.  Debt level is reached Dec 31, treasury must sell 'assets' but debt level is 'reached' again in March?   How is this determined?  Who's checking all these numbers because something smells rotten here even from my distance.

Schmuck Raker's picture

For a more complete perspective the timeline in figure one should begin around summer 2011.

Showing blank months indicative of ZERO 'progress' is more instructive than about anything else.

Muppet's picture

Don't forget the Farm Bill must be included in any resolution.   Milk subsidies expiring 12/31 will double milk prices.   Fortunately, the cliff will resolve this too.

Grand Supercycle's picture

Wile E Coyote awaits...

Whether it’s caused by fiscal cliff, debt ceiling, Europe or something else, it doesn’t really matter because as noted before – another crash is guaranteed.

It’s a no brainer.
Charts don’t lie.

Aurora Ex Machina's picture

Strange how these time-lines go; Thursday, 25th April 2013, 09:57:06 pm [partial lunar eclipse]. That's your pink / waking / Egg moon (although, old style, perhaps Wed March 27th is your Egg, but hey, we can work between the two for our purposes, from Egg to Pink / Waking).

Fun fact: another name for the pink moon is Hanuman Jayanti, to wit:

The child received his name from the Sanskrit words Hanu ("jaw") and -man (or -mant, "prominent" or "disfigured"). The name thus means "one with prominent or disfigured jaw".   Another theory says the name derives from the Sanskrit words Han ("killed" or "destroyed") and maana (pride); the name implies "one whose pride was destroyed"...According to one theory, the name "Hanuman" derives from the proto-Dravidian word for male monkey (ana-mandi), which was later Sanskritized to "Hanuman".


Let's see then; who can I think of that fits the bill of (largely) male-monkey (I know, apes, but they didn't know that), uses their jaws all too much without action, and has a surfeit of pride? (apart from this poster, of course).


Comment: don't expect much more from Congress over the next four months barring a lot of snarling and justifying their expense accounts. The real moves are being made elsewhere; and what moves they are.