Now that the US presidential elections are over, market attention is set to shift on the impending Fiscal Cliff.  The situation isn’t rare, but it does raise a lot of concerns when it comes to the future of the US economy – especially with things being the status quo.  Here’s the breakdown.

What’s In Store

In short, the fiscal cliff is simply a term referring to the situation that the US government faces beginning January 1st of next year.  At that time, several government policies will end, unleashing a bevy of tax increases and a stop on spending – to the tune of over $600 billion.  The list includes:

1.       Expiration of Bush era tax cuts which helped to lower marginal tax rates for US income earners.  The tax cuts were extended two years ago in hopes that consumer spending would increase as a result.  Without an extension, tax rates are expected to return to previously higher levels.

2.      Sharp, across the board cuts in governments pending, in both defense and domestic expenditures.  The cuts were outlined in last year’s Budget Control Act that was formed by Congressional indecision over the debt ceiling debate.

3.      Cancellation of emergency unemployment benefitsand the Obama payroll tax holiday.

4.      Activation of taxes levied by the Affordable Care Act.  The new taxes will be imposed on higher earning families, with an income of $250,000 or more.

The Effect

According to the Congressional Budget Office, the cuts are expected to trim a little over $550 billion from the deficit.  However, the $7 trillion in spending cuts and tax increases over the next 10 years is forecasted to sap about 1% from gross domestic product.  The decline in growth prospects and the sharp increase in austerity would additionally warrant a sovereign downgrade – as promised by Fitch Ratings.  In September, Fitch Ratings warned that the US would need to fix the fiscal cliff, or risk a downgrade from the current AAA rating.

How Will It End?

Although there are plenty of outcomes that are likely inthis situation, two are the most prominent. 

First, Congressional divides will ensure the country falling off the cliff - sparking impending doom for the world’s largest economy.  This scenario doesn’t bode well for the US economy and would likely ruin longer term growth prospects for the country.  Unfortunately, the scenario,although less probable, is still viable as the US elections didn’t provide any real shift in power.  Congress still remains split and is supportive of further political gridlock.  The re-election of President Obama additionally has its complications as the world leader is expected to veto any measures averting the cliff without tax increases for higher earners. 

However, there is hope. The most likely scenario involves further stop gap measures that will extend a handful of the tax cuts and reduce spending by a percentage – rather than across the board.  The solution is the most likely outcome as no party will want to bear the responsibility of casting the US economy into a downward spiral.

The Market Effect

With the impending fiscal cliff debate looming over the US,and the world, further US dollar strength is anticipated – particularly against the Euro.  The sentiment here is simply that US policymakers will likely delay an ultimate decision until the last minute, leaving a lot of uncertainty to permeate the market.  The notion will boost safer haven plays, with the US dollar in front - especially against a currency that has been battered by further speculation over a Grexit.  Subsequent tensions and concerns will add downward pressure on equity markets, as well,  with companies struggling to make a profit in a sluggish environment.