Post written by Charlie Blomfield, Managing Director, AMC
The Fiscal Cliff refers to a 2012 year-end deadline in the US featuring three key policy items:
- The expiration of the tax cuts implemented in 2001-2003 being lower dividend and long-term capital gains tax rates;
- The expiration of the temporary payroll tax cut and other miscellaneous tax breaks dating to 2009-2010; and
- Automatic spending cuts related to the temporary debt-ceiling compromise from 2011.
In August 2011, the US Congress passed the Budget Control Act 2011 which temporarily raised the nation’s debt limit by US$2.1 trillion. The legislation mandated that Congress reach a long-term solution; if not, the law calls for automatic tax increases and spending cuts to start after using that US$2.1 trillion which is set to occur in December 2012.
Moreover, the Budget Control Act 2011 lowered the projected funding for many government organizations by US$1 trillion and ordered the United States Congress Joint Select Committee on Deficit Reduction to find another US$1.2 trillion in spending cuts.
In December 2012, US$600 billion of automatic tax rises and >US$2.2 trillion in government spending cuts will be actioned. Thus, the conundrum for Congress. It’s the poison pill the US needs, just how strong should the dose be to right the ship? There is likely to be a “watered-down” compromise delivered at the eleventh hour. The worst case scenario is if the US does nothing. It is estimated that if the US take no action, by 2022 debt/GDP ratios would hit 90%. This is of course if the US evades the looming debt ceiling call in Qtr1 2013. Kick the can again.
The current issue concerning international markets in the lead up to these events is the lack of progress in talks between Democrats and Republicans on avoiding the fiscal cliff. Both sides are sending a message that they are willing to compromise and legislate although at this stage a call has not been made.
The most significant threat to soft commodity markets is general uncertainty which leads to speculation and in turn volatility. Should the US arrive at a compromise then the impact for soft commodity prices is unlikely to be a sustained decline, rather enhanced price volatility over the short-term as investors, and importantly for soft commodity markets, Hedge Funds exit positions to realise cash and invest in Treasury Bills and Government Bonds. As Hedge Funds hold substantial positions in soft commodity markets, this may lead to short-term selling and further speculation.
Commodity exporting countries will be affected most over the short-term potentially due to:
- Decreased US import volumes
- Decreased US GDP growth
- Decreased business spending
- Increased unemployment
- Decreased oil prices
- Decreased internationally-traded food commodities
When there is uncertainty in markets, consumption drops, and if consumption drops, commodity prices drop whether it’s wheat, soybeans, oil or beef. The commodity price volatility and potential declines should recover throughout 2013 as food demand, export policies, and natural forces such as weather regain control over soft commodity markets. The key is managing price volatility and dollar cost averaging over time to smooth potential impacts.