With $600 billion in tax increases and automatic spending cuts due to take effect in January, investors say they would welcome an agreement that delays most changes until Congress can hammer out a long-term deficit reduction deal in early 2013.
"At the very least, I would like to see some kind of conciliatory rhetoric on both sides of the aisle to give investors assurance that a grand deal is coming," said Jack Ablin, chief investment officer at Harris Private Bank.
Without that, things could get ugly in markets. U.S. stocks accelerated a recent losing streak in the days following this week's election, in which voters returned President Barack Obama to the White House but left Republicans in command of the House of Representatives and Democrats controlling the Senate. That same combination dragged out long negotiations over raising the debt ceiling in August 2011.
In President Obama's first public statement since the election on Friday, he reiterated his demand to raise taxes on high earners. Earlier in the day, Republican House Speaker John Boehner restated his opposition to such a move.
"What that means is that fiscal cliff negotiations are picking up exactly where they left off," said Ward McCarthy, chief financial economist at Jefferies & Co. "Fasten your seat belt, it will be a bumpy end of the year in Washington."
A majority of economists polled by Reuters said consumer and business confidence would wilt and the economy suffer if talks to head off the budget crisis collapse.
The Congressional Budget Office has warned that sailing over the cliff would trigger "a significant recession" and the loss of about 2 million jobs.
NO RETREAT, NO SURRENDER
Worries about the danger the fiscal crisis poses for the U.S. economy put global stocks on track for their worst week since June.
The main sticking point is taxes: Obama wants to raise rates on households earning more than $250,000 while Republicans want to focus on spending cuts, saying tax hikes would hurt growth.
On Friday, it did not seem either side was ready to give in. Obama said he was "open to compromise" but said a majority of voters agreed with having the wealthiest Americans pay more.
Boehner restated his opposition to raising taxes on the rich, saying it would depress hiring and growth.
In 2011, a similarly divided government's failure to agree on deficit reduction set up the fiscal cliff showdown the economy now faces.
It also provoked Standard & Poor's to strip the United States of its coveted AAA credit rating and pushed the CBOE Volatility Index <.VIX>, Wall Street's gauge of investor anxiety, to levels associated with panic.
As Congress has punted on the hard decisions, the numbers have hardly changed: Federal red ink is expected to be more than $1 trillion in 2012 for the fourth straight year.
James Dailey, portfolio manager at TEAM Asset Strategy Fund in Harrisburg, Pennsylvania, worries that investors who were complacent about the risks before the election may rush for the exit if it seems the economy is going to fall over the cliff.
"When the market starts to sell, it feeds upon fear and accelerates the sell-off," he said.
REASON TO HOPE
The issue is of such concern to investors because the U.S. economy has outperformed other developed economies and has shown signs of improving further. Recent U.S. economic data, including a survey showing consumer confidence hit a five-year high this month, has been encouraging.
"There's a lot at stake, and there's a lot of momentum that could be lost if lawmakers don't get their act together," said Joe Manimbo, analyst at Western Union Business Solutions.
Some are hopeful a deal can still be reached.
The CBO said this week that letting income tax rates rise for households earning more than $250,000 - a staple of Obama's re-election campaign - would have little impact on the economy. Not all investors disagree, as some interviewed in recent weeks said they would be willing to pay more taxes if it helped balance the country's budget.
Some, like Vassili Serebriakov, a currency strategist at BNP Paribas, also said a deal could prove easier to reach now that Obama is no longer running for re-election.
"Of course, we need to see evidence that the negotiating positions have changed," he said.
Serebriakov also said investors may be fooling themselves if they think the market will rally strongly between now and year end, regardless of what happens with the fiscal cliff.
"It's the end of the year, equities have been under pressure on the back of earnings, and there's just a lot of caution in the market," he said. "It really seems like markets will wait until early 2013 before committing to any particular view."
