Fiscal cliff euphoria fades as investor caution returns



The market rally eased on Thursday as the initial euphoria over a fiscal cliff deal faded and attention turned to further negotiations in coming months.

In Asia the Hong Kong's Hang Seng Index rose marginally and hit a 19-month high before falling and the index was down 0.1pc as it neared the end of trading.

Markets in Japan and mainland China were closed for extended holidays.

Just before the New Year, the US Treasury Secretary Tim Geithner indicated that the federal government would run up against the debt ceiling - a legal cap on its total borrowing set by Congress - by the end of February, which will need to be voted on again as it was in August 2011.

Paul Reilly at Clear Currency said: "While the vote averted immediate pain like tax hikes for almost all U.S. households, it did nothing to resolve other political showdowns on the budget that loom in coming months.

"Congress must now act as early as mid-February to prevent a default and the dispute may reprise a similar 2011 episode that led to a downgrade of the U.S. credit rating."

The euro fell against the dollar in Asia as investor confidence gave way to concerns about future budgetary rows in Washington.

The single currency bought $1.3137 in afternoon Asian trade from $1.3184 in New York late Wednesday, while it was also at 114.62 yen from 115.13 yen.

The greenback traded at 87.25 yen from 87.32 yen.

"Currency traders may be positioning themselves for the troubles that lie ahead for the US economy as Congress confronts spending cuts in two months' time," IG Markets said in a report.

"Investors realised that the fiscal problem is far from over as the debate on raising the debt ceiling looms... we expect an uglier showdown than the tax issue."

Oil prices also fell as caution returned to markets. New York's main contract, light sweet crude for delivery in February dropped 18 cents to $92.94 a barrel in the afternoon and Brent North Sea crude for February delivery shed 29 cents to $112.18.

"The market lost steam after the excessive buying of oil in reaction to the passing of the US fiscal cliff deal," Victor Shum, managing director of IHS Purvin and Gertz in Singapore told AFP.

"Some caution has returned to the market. After all, there are going to be more negotiations in the fiscal deal in the next two months."

Global financial markets soared yesterday after the US Congress backed a stop-gap agreement that averted across-the-board tax hikes and automatic spending cuts which some had feared could tip the economy back into recession.

The FTSE 100 closed up 2.2pc at 6,027.37, adding £32.8bn to the value of Britain's top companies.

The FTSE 100 breached the psychological 6000 level within two hours of the start of the first trading day of the new year, and Wednesday's rise is the biggest since the end of November (Xetra: A0Z24E - news) , when it climbed 2.36pc.

The Dow Jones Industrial Average closed up 2.35pc - or 308.41 points - at 13,412.55. The tech-rich Nasdaq gained 3.07pc, while the broad-market S&P 500 gained 2.54pc.

Shares in Germany, France, Italy and Spain made strong gains of between 1.9pc and 3.8pc.

The US agreement is seen as a step towards correcting the country's public finances which are showing a huge annual deficit and accumulated mountain of debt.

Cantor Index analyst David Buik said: "There was never any chance of there being anything worse than a fudged agreement on the proposed budget, including taxation increases for the better-off.

"The ramifications of no agreement were not worth considering."

The extraordinary late-night House of Representatives vote took place less than 24 hours after the Senate passed the measure in the predawn hours on New Year's Day.

The bill's passage on a 257-167 vote in the House of Representatives sealed a hard-won political triumph for the president less than two months after he secured re-election while calling for higher taxes on the wealthy.

Moments after the deal was done, President Barack Obama strode into the White House briefing room and said: "Thanks to the votes of Republicans and Democrats in Congress I will sign a law that raises taxes on the wealthiest 2pc of Americans while preventing tax hikes that could have sent the economy back into recession."

The US deficit was still too high, he said: While open to compromise on budgetary issues, he would not offer Congress spending cuts in return for lifting the government's borrowing limit, known as the debt ceiling.

"There is a path forward, if we focus not on politics, but on what's right for the country," said Mr Obama.

He spoke with Vice President Joe Biden at his side, a recognition of the former senator's role as the lead Democratic negotiator in final compromise talks with Senate Republican Leader Mitch McConnell of Kentucky.

In addition to neutralising middle class tax increases and spending cuts that technically took effect at midnight on Monday, the legislation raises tax rates on incomes over $400,000 for individuals and $450,000 for couples.

The Senate approved the measure on a vote of 89-8 less than 24 hours earlier, and in the interim, rebellious House conservatives demanded a vote to add significant spending cuts to the measure. But in the end they retreated.

The measure split the upper ranks of the Republican leadership in the House. Speaker John Boehner of Ohio voted in favour, while Majority Leader Eric Cantor of Virginia and California Republican Kevin McCarthy, the party's whip, opposed the bill.

Supporters of the bill in both parties expressed regret that the bill was narrowly drawn, and fell far short of a sweeping plan that combined tax changes and spending cuts to reduce federal deficits. That proved to be a step too far in the two months since Obama called congressional leaders to the White House for a post-election stab at compromise.

Majority Republicans did their best to minimise the bill's tax increases, just as they abandoned their demand from earlier in the day to add spending cuts to the package.

House Democratic Leader Nancy Pelosi also said the legislation included "permanent tax relief for the middle class," and she summoned lawmakers to provide bipartisan support as the Senate did.

The bill would prevent an expiration of extended unemployment benefits for an estimated two million jobless, renew tax breaks for businesses and renewable energy purposes, block a 27pc cut in fees for doctors who treat elderly Medicare patients, stop a $900 pay increase for lawmakers from taking effect in March and head off a threatened spike in milk prices.

The bill would also raise the top tax rate on large estates to 40pc, from 35pc, and taxes on capital gains and dividends over $400,000 for individuals and $450,000 for couples would be taxed at 20pc, up from 15pc.

It would stop $24bn in spending cuts set to take effect over the next two months, although only about half of that total would be offset with spending reductions elsewhere in the budget.

Even with enactment of the legislation, taxes are on the rise for millions.

The higher taxes on the wealthy - which will deliver some $600bn in revenue over 10 years - are likely slow the economy a little bit.

But a bigger drag on the economy will come from a tax hike Democrats and Republicans didn't even bothering to fight over: the end of a 2 percentage point temporary cut in the Social Security payroll tax, originally enacted two years ago to stimulate the economy, expired with the end of 2012.

The so-called payroll tax is scheduled to bounce back up to 6.2pc this year from 4.2pc in 2011 and 2012, amounting to a $1,000 tax increase for someone earning $50,000 a year.

"It's a huge hit," says Joel Naroff, president of Naroff Economic Advisors. "It hits people whether they're making $10,000 or they're making $2 million. It doesn't matter who you are ... The lower your income, the more of your income you're (spending). So if you're taxes go up, it's going to come out of your spending."

That is bad news for an economy that is 70pc consumer spending.

The non-partisan Congressional Budget Office said the deal would add nearly $4 trillion over a decade to federal deficits, a calculation that assumed taxes would otherwise have risen on taxpayers at all income levels.

If Mr Obama and Congress failed to act, about $536bn in tax increases, touching nearly all American workers, and about $110bn in spending cuts, about 8pc of the annual budgets for most federal departments, were scheduled to start going into effect beginning in January.

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