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BofA Merrill Lynch Global Research – A US Economics Report – Monday, 19 November 2012

A better tomorrow, tomorrow

It has been less than two weeks since the election and already sentiment about the fiscal cliff has shifted twice. For several days after the election there was promising talk of compromise. This quickly gave way to both parties hardening their positions on tax increases. This, in turn, was followed by an encouraging meeting at the White House on Friday. The New York Times wrote that the negotiations started with “some surprising bonhomie, and even some initial agreements toward year-end.” Here we look at what was and wasn’t accomplished last Friday, and reiterate our view that some tough negotiations lie ahead.

The meeting did represent a step forward. They abandoned the hopeless idea of reaching a quick “grand bargain” and agreed on a practical two-step process: (1) replace the fiscal cliff with a down payment of at least $50 billion in deficit reduction, and (2) define a framework for a more comprehensive agreement later. As the Times quote suggests, they also left the meeting in a cordial mode, with several of the negotiators expressing optimism about getting a deal before year-end.

We see several reasons for caution:

 Tight calendar: While the various staffs can start working on proposals, there will be no further negotiations until after Thanksgiving week. Christmas week will force another recess.

 Missing in action: While the negotiators addressed the two most important parts of the cliff-the Bush tax cuts and the sequester-they ignored two-thirds of the cliff, including the payroll tax cut ($120 billion), extended unemployment benefits ($40 billion), the Obamacare tax increase ($20 billion), the annual “mini cliff” including the Medicare Doc Fix, the AMT patch and tax extenders ($160 billion), and a variety of other programs that are expiring under the radar screen ($90 billion).

 The other cliff: They also did not start to negotiate what to do with the debt ceiling. House Speaker Boehner has repeatedly said he will use the ceiling to extract further cuts. Under current trends, the government will hit its ceiling in January and run out of room to maneuver in March. The ceiling requires an immediate balancing of the deficit and hence hitting it would be a bigger shock than going over the cliff.

 

 

Read the full report here.