Fidelity's Fiscal Cliff Scenarios

Full disclosure I maintain a personal 401k account at Fidelity and manage client accounts at Fidelity.  Hat tip to Josh Brown at The Reformed Broker.

I agree with Fidelity's scenario 1: punt that there will be some type of delay but like the debt ceiling debacle they will run it up to the very end before making a decision.  I would expect markets to be volatile likely to the downside leading up and then rally either right before the announcement or just after.

I also agree with Josh that the term "Fiscal Cliff" is now making it into the vocabulary of mainstream America.  No different than "Weapons of Mass Destruction".

Fiscal cliff ahead: What it may mean

Risks to the economy and stocks are high if all tax hikes and spending cuts take effect.

• Fidelity Viewpoints
• – 06/25/2012

• Capital View

Without congressional action, up to $600 billion of expiring tax cuts, new taxes, and automatic spending cuts are set to take effect at the end of 2012 or beginning of 2013. If they hit all at once, the impact could amount to as much as 4%-5% of GDP, according to our research, the equivalent of falling off a “fiscal cliff.” Some experts anticipate the economy would experience a significant slowdown and there would be major consequences for financial markets.
What are the odds that Congress will fail to act? And what could the range of possible congressional actions mean for the economy, and the financial markets? Could we experience a repeat of last year’s debt ceiling drama and credit rating downgrades?
We gathered four Fidelity experts to answer these questions and more.

Capitol scenarios

Gary Blank, senior vice president, public affairs and policy

Federal Reserve Chairman Ben Bernanke and a number of observers have used the term “fiscal cliff” to describe several big fiscal events set to occur in the U.S. at the end of this year and in early 2013. Among them:

• The expiration of the Bush-era tax cuts at the end of 2012, including current lower tax rates on capital gains, dividends, income, and estates, as well as number of other measures.
• The expiration of fiscal stimulus measures, such as the payroll tax cut and extended unemployment benefits.
• Spending cuts scheduled to be triggered automatically in January 2013 as a result of the failure of the deficit reduction super committee last year.

Depending on estimates, the impact of all these actions taken together would be a fiscal shock on the order of $300 billion to $600 billion in just one year. Such policies would reduce the budget deficit and begin to address the nation’s increasingly worrisome debt situation. However, economists generally agree that allowing the fiscal cliff to take effect in full, at the same time, could have a substantially negative impact on the economy in 2013. But that isn’t necessarily going to happen. I see four possible scenarios.

Scenario 1: punt

A likely scenario is that Congress and the president agree to punt the issue into 2013. If this occurs, the tax cuts will not expire, tax increases won’t take effect, and the spending cuts will be delayed until after the presidential inauguration and new Congress arrives in 2013.

Scenario 2: modest compromise

Congress and the White House reach compromises on some tax and spending provisions, with the election having a significant impact on what those compromises might be.

Scenario 3: over the cliff

A less-likely scenario, I think, is that Congress and the White House fail to reach any compromise whatsoever and are unable even to agree on how to delay the looming measures. The economy goes over the cliff.

Scenario 4: grand bargain

In my view, the chance of a grand bargain taking place after the election and before the end of the year is a long shot. In this scenario, Congress and the White House would reach a deal addressing tax, spending, and fiscal issues for the medium to long term.

In addition to the fiscal cliff, the U.S. will again approach the debt ceiling early next year. While the sequence of events puts the debate over the fiscal cliff before the debt deadline, the two issues are likely to be intertwined.

The outcome of the 2012 elections matters, but the resolution of these issues is tough regardless of whether Democrats or Republicans are in control. That’s because they reflect longstanding philosophical differences between the parties about the proper role and size of the government, and how to grow the economy.