The Best of Kass
In understanding why we will likely see a timely fiscal cliff compromise, it is essential to also go back to the November election, in which the message was one of moderation, and moderation equates to an ultimate compromise.
Some market participants (and certainly the media) seem to be now incorrectly playing the last war (which took place during the budget deliberations in August 2011). By contrast, I believe that fiscal cliff fears are likely misplaced, as we are at the point of necessity, and my view is that both parties get this. Sleeves will be rolled up in the next three to four weeks, and the outcome will likely be a relatively pro-economy/pro-business compromise with multiple concessions from both sides.
Compared to the budget deliberations of August 2011, this time around neither party can risk the perception of being obstructionists in the negotiations. Americans clearly have voted with their feet, and they want and prefer compromise over drama.
Once Bitten Twice Shy
My bet is that having been disappointed once and with the domestic economic recovery still subpar, we won't be disappointed twice. Fifteen months ago, neither the Democrats nor Republicans thought through the consequences of their partisanship. This time, they have clear knowledge of the potential adverse impact of stalled negotiations regarding the fiscal cliff -- both with regard to the economy and our stock market.
Arguably, both parties are now damaged goods (though for different reasons) and have to prove that they can legislate for the common good rather than on partisan terms. They cannot afford to do otherwise; they are not likely to make the same mistake twice.
Both parties find themselves in trouble, neither party is trusted (the overall voter turnout was weak), and it appears that Democrats and Republicans finally might/should recognize that the serious secular financial and economic problems should be addressed in a more bipartisan manner.
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.