In the debt negotiations during the summer of 2011, the electorate was appalled by the partisanship and lost confidence in our leaders. They must earn that confidence back by resolving some of their differences. (They will have another two years before the 2014 elections to posture on a partisan basis.) It is my expectation that both parties will likely move toward the center in the fiscal cliff negotiations and will reject the more extreme members of their respective parties in making concessions to each other.
Again, the 2012 election was a win for the moderates. Compromise and agreement between the two parties remains my baseline expectation.
I expect the final fiscal compromise will produce only about a 1% fiscal drag in 2013, which will easily be overcome by a better-than-expected housing recovery and by improved business confidence, hirings and business fixed investment spending.
Geithner's Proposal Gets the Silent Treatment
The market's resilience in the face of early legislative posturing appears to be sending a strong message that the fiscal cliff will be resolved in a timely fashion by year-end.
Case in point: Yesterday Treasury Secretary Geithner (representing the Obama administration) delivered a one-sided proposal to the Republicans. His proposal offered $1.6 trillion in tax increases and only $400 billion of unspecified (and non-guaranteed) entitlement program cuts over the next 10 years. The 4:1 ratio of tax increases to spending cuts was a partisan and unbalanced proposal, far more lopsided than the tentative agreement made between the President and the Speaker of the House in 2011 and imbalanced relative to the Simpson-Bowles proposal (which had more in spending cuts relative to tax increases).
Upon release of this one-sided proposal, the market's reaction was muted, with S&P futures dropping by only 4 handles.
Why didn't the market collapse upon receipt of the administration's proposal?
The answer is quite simple: The market recognizes that Tim Geithner delivered only the first proposal from the Democrats at the beginning of negotiations. The administration has absolutely no intention to stick to the proposal -- if it did, the House would soundly vote down the proposal and the full extent of the fiscal cliff's drag would be felt in the first half of 2013 (causing a recession and a sharp stock market fall).