Bank of America Merrill Lynch - "The US fiscal cliff is looming as the biggest “known unknown” facing the markets. Over the past few months the financial press has been catching up with the theme. Media reports stress not only the magnitude of the potential shock – a 4.6% of GDP fiscal contraction – but also the fractious political backdrop hindering the cliff’s resolution. Our latest Fund Manager Survey found that the Cliff is now the number one concern of investors. Both hard data and anecdotal evidence suggest US businesses are pulling back, indicating that 4Q activity will likely strike a weak tone. In particular, this week’s poor US durable goods report supports our long-held view that capex would start wobbling in 3Q.
From an international contagion standpoint, jumping over the cliff would be a major shock. US growth is largely driven by domestic demand, and countries that rely on domestic demand rather than exports tend to have larger spillover effects to the rest of the world. Moreover, IMF researchers have found that the potential size of cross-border spillovers from the US has increased in recent years1. Finally, the fiscal cliff is a wholly US-made crisis. This means that US fiscal contraction would hit the global economy as a brand “new” shock. All told, although US policymakers will likely avoid some of the Cliff, a 2% of GDP fiscal pullback would still be painful to outsiders given the soft state of global growth."