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Fiscal Cliff Likely To Slow Growth, But Not Cause Recession, According To Standish

NEW YORK and LONDON, Oct. 25, 2012 /PRNewswire/ -- The U.S. fiscal cliff is not likely to send the economy into a recession, according to the October Bond Market Observations from Standish Mellon Asset Management Company LLC, the Boston-based fixed income specialist for BNY Mellon.

For bond investors, Standish said this means there could be opportunities in U.S. corporate credit markets.  Both U.S. investment grade and high-yield bonds over the last 20 years have posted positive excess returns when U.S. economic growth ranged between one percent and two percent, the report said.

Standish believes that a combination of recent actions by the Fed and an expected compromise deficit reduction package would be enough to prevent a recession.  The Fed's asset purchase program has eased financial conditions and supported the housing market.

If no action is taken to avoid the fiscal cliff, tax hikes and spending cuts amounting to 4.8 percent of U.S. gross domestic product (GDP) will go into effect on January 1, 2013, the report notes.  However, Standish said a compromise deficit reduction package could reduce this drag to 1.4 percent of GDP. 

"While we don't see much room for cooperation between the Democrats and the Republicans on addressing the fiscal cliff, we also doubt either party will want to be held responsible for engineering a U.S. recession by allowing the entire $807 billion in deficit-cutting measures to take effect," said Thomas Higgins, global macro strategist for Standish.

Among the deficit-reduction efforts that Standish does expect will be an end to the two-percentage point reduction in the Social Security payroll tax, which has benefited U.S. households over the past year.   The Social Security program already is underfunded, and extending the payroll tax reduction will aggravate this shortfall, according to the report.

Standish also expects the Medicare payroll tax increase and the new surtaxes for high income tax payers on dividends and capital gains associated with the Affordable Care Act to become effective unless the Republicans sweep the Presidency and Congress.

"Under our base case scenario, the U.S. economy will suffer a fiscal drag of roughly 1.4 percent of GDP next year and U.S. real GDP growth will decelerate from 2.1 percent in 2012 to 1.4 percent in 2013," Higgins said.

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