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Fiscal cliff Q&A: what does it mean for investors?
Markets appear ecstatic with last night's deal to avoid sweeping tax rises in the US. Job done?
What has been achieved?
After long negotiations US democrats and republicans have finally found a compromise to prevent sweeping tax rises that threatened pushing the US economy into recession.
A bill was passed first in the Senate and then in the House of Representatives. Only President Barack Obama’s signature is now needed.
This is a victory of sorts for Obama as wealthy Americans will pay more tax – as George W Bush era income tax cuts will expire for top earners, but not for other workers – among myriad other measures.
What’s left to do?
Lots. This is far from the ‘grand bargain’ Obama had hoped for.
While seeing off tax hikes, the threat of spending cuts has not been overcome, merely delayed. The so-called sequester has been postponed for two months, allowing Congress more time to strike a deal to prevent automatic spending cuts.
Is that it?
No. Congress also must soon raise the ‘debt ceiling’ after the US hit its debt limit of $16.4 trillion on New Year’s Eve. Treasury secretary Timothy Geithner has taken ‘extraordinary measures’ to create ‘headroom’ (his own words) which would keep a theoretical default at bay for another couple of months.
Congress has never failed to raise the debt limit – actually it has done so more than 70 times in the past half decade – but the last-minute negotiations of Summer 2011 were tense enough for Standard & Poor’s to strip the US of its AAA credit rating.
But that’s not all. The US hasn’t actually passed a law for a 2013 budget, even though the fiscal year began in October. If a ‘continuing resolution’ that expires in March is not extended the government could be partially shutdown; literally suspending operations. And this has happened before.
Obama last night said he hopes future negotiations will entail ‘less drama, a little bit less brinkmanship, not scare the heck out of folks quite as much’. But the world’s most powerful man may not get his wish.
Why did it take so long?
The drawn-out negotiations over the deal reflect a fundamental political divide between republicans and democrats over the size of government, entitlements and tax rates. It also reflects just how polarized US congress has become.
According to US press reports, neither party was entirely happy with the result. However, as Republican Lou Barletta told the Washington Post: ‘I don’t know if playing chicken with the American people at this point is in the best interest of the people.’
What does it mean for investors?
The response from markets was unequivocal: the deal is good.
Markets around the world rose, with Britain’s FTSE 100 finally breaking out of a narrow range to climb above the 6,000 mark for the first time since July 2011.
Emboldened investors sought out riskier assets such as bank shares, the euro and commodities.
Yet weary market commentators say the deal (which most of them had expected) resembles the sort of political fudges achieved by bickering eurozone politicians: markets typically enjoy a relief rally – such as they are today – before the reality sets in that this-isn’t-over-yet.
Where does this leave the US economy?
Well, at least not in a deep recession.
However, the bill will do little to tackle America’s growing debt pile. In fact the legislation adds nearly $4 trillion to US fiscal deficits over the next decade, according to the Congressional Budget Office.
Crucially, the ratings agencies are yet to cast judgement, but no doubt they’ll maintain a sceptical eye on the outstanding budgetary issues.
While not spectacular in 2012, pitched against its developed world counterparts, the US economy doesn’t look so bad.
The housing market has started to turn around, unemployment is falling (though still high) and the Federal Reserve stands ready to do whatever it takes to encourage both of these trends.
Today’s news removes a significant source of uncertainty for consumers, investors and businesses.
What else should investors be worried about this year?
While an important hurdle has been removed, US fiscal policy will remain a concern for global investors. Among commentators responding to today's news, Mike Turner, head of global strategy and asset allocation at Aberdeen Asset Management, was among the most gloomy: 'The tax rises agreed by the House of Representatives last night may have averted a near-term recession, but an economic crisis induced by the deteriorating credit worthiness of the United States, still looms,' he said.
Like this time last year, politics remains at the top of investors’ list of threats in 2013.
Elections in Italy and Germany will remind investors what is at stake in the stuttering eurozone. Likewise the growing debate in the UK about EU membership will keep the focus on European fracturing.
Spain meanwhile continues to keep markets guessing about whether it will finally seek a full bailout. As in other austerity-ridden European nations, enraged Spaniards could take to the streets again and in turn spook investors.
Global growth prospects remain weak, but sluggish growth wasn’t enough to prevent strong stock market rises in 2012. Most investment houses and banks are remarkably upbeat about the prospects for markets in 2013. At least the Chinese economy appears to have avoided a ‘hard landing’ while we don’t have a 2012-style string of major elections and leadership changes to rock markets.
Watch 'What investors can look forward to in 2013':
I want more detail: where should I go?
The BBC’s Mark Mardell explains why Obama has developed a relish for the fight:
The New York Times provides more detail on how the relief rally could peter out:
The newspaper also gives a taste of the debate among Republicans:
Try this for more detail on what has been agreed:
And the White House has this (decidedly partisan) explainer on the Bipartisan Tax Agreement:
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More from us
- Bullish investors set to pounce on bond-like shares
- FTSE breaks through 6,000 after US averts dreaded fiscal cliff
- Get ready for a 'Great Rotation' in stock markets
- What investors can look forward to in 2013
What others are saying
- Washington Post
- NYT: Even With Fiscal Agreement, Investors Facing Imminent Obstacles
- NYT: Lines of Resistance on Fiscal Deal
- CNNMoney: Fiscal cliff deal stops many tax hikes, but leaves big issues pending
- What You Need to Know About the Bipartisan Tax Agreement
- BBC News: Shoving the battle down the road
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