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Traders Calm as CBO Warns Fiscal Cliff Will Put Us Back in Recession


I can't believe this is happening again. Three and a half years after the trough of the financial crisis in 2009 the R-word is once again being thrown around. The latest purveyor of pessimism is none other than the Congressional Budget Office (CBO), who warned in a note this week that our fledgling recovery could slip back into recession as we speed toward the edge of a dangerous "fiscal cliff."

While the mere thought of going backwards again, economically speaking, is unpleasant to think about, if it does comes true it would be disastrous for markets in 2013—here and globally. And yet the markets are uncharacteristically calm, considering there's only about a six-month cushion between now and the expiration of the Bush-era tax cuts, there's a 2% payroll tax holiday ending, and the curtailing of extended unemployment benefits.

"I would prefer to see them extended until the economy is a little healthier, but it wouldn't be the worst thing in the world if they didn't," says Barry Ritholtz, author of The Big Picture blog and the book Bailout Nation.

Using the CBO's figures, if Congress does nothing (imagine that!) the collective impact of spending reduction and tax increases would shrink the deficit by $607 billion dollars. While that sounds wonderful, Capitol Hill's accounting arm says it amounts to about 4% of GDP, a significant enough headwind to produce a -1.3% growth rate for the first half of next year. Although they forecast a rebound in the second half, which would be enough to still keep the full-year figure positive.

"It will raise a little revenue and slow down growth a bit," Ritholtz predicts, arguing that marginal or modest tax rate tweaks don't produce the draconian effects that many deficit hawks fear. As he sees it, a 3—4% rate change is "not worth the time, energy, and money" for people to go out and set up an offshore corporation.

As much as the market appears to be focusing on matters abroad rather than the pending problems domestically, Ritholtz says he is currently much more defensive.

"We're about 40% exposed to equities right now, down from 80% in the first quarter," he discloses. He goes on to say that we could be in for some more ''backing and filling" this summer until the next leg up begins.