The US recovery is hurtling off a fiscal cliff

Markets had a shaky week due to the impending stand off in Congress over the annual budget and the debt ceiling. Republicans and Democrats are negotiating to extend the federal government’s spending authority, which expires when the fiscal year ends on 1 October. If there is no deal by then, the government would have to stop all non-essential spending and many public-sector workers would not be paid.

Congress also needs to raise the debt ceiling – the legal limit on how much America can borrow – by mid-October if the Treasury is not to run out of money. The worry is that America’s failure to honour its debts could trigger a financial crisis, given how much debt is priced off American borrowing. Negotiations are especially fraught this time because Republicans in the House of Representatives are insisting that funding for President Obama’s new health care programme, which became law in 2010, be eliminated.

What the commentators said

Markets are in for a rough few days, according to ING’s Tom Levinson. “There is little coming out of Washington right now to suggest Congress will avoid taking debt ceiling talks to the wire.” We learnt in 2011 that “these shenanigans have real, negative consequences”, said Randall W Forsyth in Barron’s. And the trouble is that as we “hurtle towards a new fiscal cliff” the economy is already slowing. Annual GDP growth is set to slow from a pedestrian 2.5% in the second quarter to 2% in the third.

Fiscal crises have “taken the steam out of the US recovery”, said the Financial Times. They remain “the chief obstacle to more robust growth”. In 2011 spending cuts were imposed at a fragile point in the recovery, while another stand off resulted in automatic spending cuts of 10% in all government departments. This fiscal headwind has reduced this year’s growth rate by more than 1% of GDP, and will cut next year’s figure by around 0.7%.

Expect a “bare-bones” deal at the last minute, said Capital Economics. But don’t expect the issue to fade away quickly. A bill to fund the government until mid-December is now being debated, so the spat could flare up again then. That will compound the uncertainty over when the Federal Reserve could begin to ‘taper’ its quantitative easing programme. It could be an unhappy Christmas for investors.