Not since the aftermath of Lehman have economists entered the Christmas shopping season with such foreboding. Consensus predictions for next year’s growth in the US, UK, eurozone and Japan are all lower than any December since 2008. Awful manufacturing data from the US on Monday suggest little Christmas cheer ahead.
Yet, markets were not too bothered by the ISM survey of purchasing managers hitting a three-year low. The theory is that it was hit by Hurricane Sandy and that companies are cutting back (new orders plunged) ahead of the fiscal cliff. Once Washington’s warring politicians cut a deal to avoid January’s tax hikes and spending cuts, corporates will turn out only to have delayed, not cancelled, projects. As spending returns, the poor ISM figures will be just a blip.
There are “bad news is good news” interpretations too. The Federal Reserve’s Operation Twist, which has seen it sell short-dated Treasury bonds and buy $45bn of longer-dated bonds each month, is ending. Signs of economic trouble could encourage the Fed to replace Twist with an expanded quantitative easing, QE3-plus.
Furthermore, the worse the real-world reaction to the failure of politicians to compromise, the greater the pressure on them to act.
Unfortunately, after some initial encouraging signs there is little evidence of Democrats and Republicans doing a deal.
The fiscal cliff itself is really a series of cliffs, with only the first on January 1.
Markets seem reasonably confident that a deal will be done soon. But there is little incentive to act until the real deadline looms, and that does not come until late February or early March, when the Federal borrowing limit must be raised to avoid default.
Corporate spending is likely to stay on hold until the fiscal cliff is resolved, so a long wait will start to hurt the economy. Unless politicians change the way they usually behave, investors should prepare for more dire data ahead.