Fiscal Cliff Weighing Heavily On Confidence

by: Price Point

Consumer Confidence Index Takes a Dip

The Consumer Confidence Index, which measures the American public's sentiments every month, posted a larger-than-expected decline in December. The index dropped to 65.1 from 71.5 in November, representing the largest drop in consumer confidence since the country's credit rating was lowered in August 2011. Early in the year, the index reached a four year high of 73.1 in October.

The Conference Board-- the research firm behind the index-- noted the drop was likely due to the fiscal cliff and the country's leaders' failure to reach a deal to avert spending cuts and tax hikes that automatically kick in next week.

In the week ended December 22, the jobless claims dropped by 12,000 to 350,000. Continuing claims also dropped, declining to 3,206,000 from 3,238,000. Despite the continued improvement in claims and an improvement in the present situation, which now stands at 62.8 compared to 45.9 in July, overall consumer confidence for December fell by more than 6 points to 65.1, vs. consensus forecast of 70.0 and revised November figure of 71.5. The December level is the lowest since August.

Concerns about the fiscal cliff caused the future expectations index to drop by 14.4 to 66.5 in December, its weakest reading since November 2011. The drop in expectations was across the board. The consumer expectations of business conditions, employment and incomes six months from now all declined.

Dean Maki, an economist at Barclays Capital, said the report showed consumers "recognize that they face a large potential drop in income if no agreement on the fiscal cliff is reached soon."

Guy Berger, an economist with RBS Securities, said "People are realizing that we may not get a compromise and they're getting nervous. It's a precarious situation. So far consumers are worried about the future. Once they start worrying about the present, we're in trouble."

Interestingly, the present situation of the consumer confidence index is standing at more than 16 points higher than in August this year, and its highest level since August 2008. "It takes a while for consumer confidence to go up but it takes just a short while for consumer confidence to go down," said Chris G. Christopher Jr., senior principal economist at IHS Global Insight. "The fiscal cliff has put a damper on things, and retailers are going to feel it in December."

The labor differential-- the difference between those saying jobs are plentiful minus those saying jobs are hard to get-- improved slightly in December, the highest level since September 2008, but remains very negative at -25.3.

On a more positive note was that new home sales rose 16,000 to 377,000 in November, a YoY increase of more than 15%; however, consumer buying plans suggest there is little appetite for future purchases of homes and even less for furnishing the homes that have been bought. Consumer buying plans fell for appliances but rose for Autos.

Where We Stand With The Fiscal Cliff

Talks on the fiscal cliff have resumed but there is no agreement yet. However, discussions are expected to continue over the weekend. While it is possible that a deal will be reached by year end, a retroactive January deal seems more likely. There's no political agreement yet and more importantly, not enough time left till the deadline.

Agreement by year end - If an agreement is reached before year-end, it will more likely be a scaled-down agreement addressing only the scheduled policy changes for the year-end and leaving other issues such as a hike in the debt limit and fiscal reforms for later. President Obama didn't include a debt limit increase in the recently announced proposal, and it is more likely to be omitted from a scaled-down agreement. It is possible that such a deal could delay all of or a part of the spending cuts for a short period, but it is highly unlikely that such a deal will not address sequester at all and leave it to be dealt with in early next year.

No agreement by year end - We think it is more likely that a deal will not be reached by the year end, an early January agreement seems more likely. The main effect of this lapse would mainly come through confidence. To some extent, risks associated with the fiscal cliff already seem to have weighed on consumer confidence. Consumers are more optimistic about the current situation but are more pessimistic about the future, as above discussed figures reveal as well. We believe a temporary lapse should not have significant effects, provided there is certainty about the eventual agreement and that it will be a retroactive agreement.

Sovereign Ratings - Another big question surrounding fiscal cliff and debt limit is how it will affect the ratings. Standard & Poor's and Moody's, two of the three main rating agencies, have indicated that regardless of how the fiscal cliff is resolved, they are unlikely to lower their ratings. Both agencies acknowledged that economic uncertainty and a recession is likely due to a sharp fiscal contraction, but the contraction would also probably be enough to slightly lower or stabilize the most important criterion to sovereign ratings, the debt/GDP ratio. However, the third big rating agency, Fitch, is indicating a possible downgrade if the fiscal cliff is allowed to take effect for long enough or if the debt limit is not raised in time.

Who would have thought this is how the year would end, but it looks like our leaders have made it a habit to take it down to the wire.

We wish you all a very happy new year!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.