The markets are already fretting over the "fiscal cliff": On Thursday, the Dow seemed to surge and fall with every bit of micro-news about a deal or lack thereof, as Joe Weisenthal documented.
It's an indication that the markets are increasingly anxious about the prospect of cliff-diving: If we go over, economists believe that the market fallout could be very quick, though we'd have a few weeks before the country would actually hit a recession.
"Investors won't react violently at first, but financial markets would steadily weaken day by day. By late January, if there is no deal, they would be selling off sharply anticipating the developing recession," says Mark Zandi, chief economist for Moody's Analytics. If Congress and the White House don't act before early February, the country would plunge into a recession, he concludes.
Ethan Harris, head of North America Economics for Bank of America Merrill Lynch, says that the stock market has held up fairly well so far, but that a cliff dive could result in a plunge of 10 percent or more. A few weeks without a resolution could drag growth down in the first quarter of 2013 somewhere "between 0 and 1.5 percent," Harris adds. (A recent survey of business economists predicted 1.8 percent first-quarter growth before it looked like we were heading over the cliff.)
The irony is that the worse the immediate market and economic reaction to a cliff dive, the quicker Congress and the White House might be scared into reaching a deal, as they did during the battle over TARP. If there isn't as sharp a reaction, the stalemate could drag out for longer.
There already are signs that the fiscal cliff is beginning to take a toll on the economy, and that trend would sharpen with a cliff dive: Businesses have already put off capital spending, and consumers who have remained largely oblivious to the cliff drama have started to pull back as well. "It has already contributed to a soft holiday shopping season, and the sharp drop in consumer confidence in December is a warning of even deeper weakness in January," says Harris.