On the edge

Fiscal cliff countdown: Wall Street nerves ignored by markets in this region as deadline nears.

Many investors believe that the higher taxes and lower government spending after a fiscal cliff plunge could push the US back into recession. Photo / Getty Images
Many investors believe that the higher taxes and lower government spending after a fiscal cliff plunge could push the US back into recession. Photo / Getty Images

Markets in this region yesterday shrugged off the threat of economic disruption from the looming "fiscal cliff" in the United States which caused stock gyrations and consumer confidence there to plummet.

In the US the fiscal cliff took the stock market on a rollercoaster yesterday. Small developments in the tense budget standoff yanked stocks back and forth throughout the day.

In the end, US stocks closed lower for the fourth day in a row, sending the unwelcome message that the budget standoff is still far from solved, the economy still far from healed.

In early trading Asian stock markets rose yesterday, hours before President Barack Obama and key politicians were to meet at the White House to try to hammer out an 11th-hour budget compromise.

In Japan the Nikkei 225 index marched higher, hitting its highest level since March 20, 2011. Hong Kong's Hang Seng rose slightly and Australia's S&P/ASX 200 closed up 0.5 per cent to a 19-month high.

In New Zealand the dollar gained in local trading on optimism US politicians will be able to set aside partisan differences. The kiwi rallied during the day after news of a planned meeting by US politicians came out. New Zealand shares also rose, pushing the NZX 50 Index to a new five-year high.

But the erratic performance of the US market underscored how the fiscal cliff can yank the market back and forth. Stocks opened by hopping between small gains and losses, pulled up by news about fewer unemployment claims and down by the continuing lack of a budget deal in Washington.

Then, stocks turned decisively downward at mid-morning, unnerved by twin fetters: a report that consumer confidence fell to its lowest level since August, and a warning from the Senate majority leader, Democrat Harry Reid, that he feared the Government would miss the deadline for working out a budget compromise.

A bright spot of economic news, an increase in sales of new homes, couldn't distract investors from worries about the budget impasse. Both Republicans and Democrats demanded that the other side take the initiative in compromising. The Dow Jones industrial average fell as much as 150 points, more than 1 per cent.

Then, just as the Dow appeared headed toward a triple-digit loss, it whipsawed again, this time higher, after House leaders announced in the late afternoon that the chamber would meet on Monday (NZT) to work on the budget.

At the close, stocks trimmed their losses but still finished lower. Until recently, investors were treating the "fiscal cliff" with a measure of nonchalance. Stocks rose more or less steadily from mid-November until late last week.

But now, with the "fiscal cliff" deadline just days away and no deal in sight, more investors are paying attention.

"This is a matter of a few personalities; it isn't something where you can analyse spreadsheets to figure out what's going on," said David Kelly, chief global strategist at JPMorgan Funds. "There are very few investors on one side or the other who have wanted to make a strong bet on this one."

Many investors believe that the higher taxes and lower government spending could push the US back into recession.

"This is not small potatoes," said Hugh Johnson, chairman and chief investment officer of Hugh Johnson Advisers in Albany, New York. "We're not going to miss a recession by much in 2013 as it is."

Chief strategist at US Bank Wealth Management Jim Russell said: "The markets remain held hostage to the perceived negotiations in Washington regarding the fiscal cliff."

To be sure, plenty of traders think the "fiscal cliff" is overhyped. Even if the government misses the deadline, the higher taxes and lower government spending would take effect only gradually, and Congress could always repeal them.


What going over the cliff means

Congress and the White House are struggling to avoid the "fiscal cliff", the package of huge tax increases and spending cuts that kick in in the United States next year unless a budget agreement is reached first.

Going over the cliff would raise most Americans' taxes and could damage an already-weak economy.

The nonpartisan Congressional Budget Office says leaving the tax increases and spending cuts in place for a year would push the economy into recession in the first half of 2013.

Still, if the economy goes over the cliff for a month or two, rather than a full year, growth would slow, but a recession would probably be avoided.

Here are some questions and answers about the cliff:

What's in the fiscal cliff?

About four-fifths of it involves tax increases. Income tax cuts that took effect in 2001 and 2003, and tax credits in a 2009 economic stimulus package, expire on January 1. A cut of 2 percentage points in the Social Security tax rate will also end. And spending would be slashed sharply and broadly. Defence spending would plunge nearly 10 per cent. Layoffs by defence contractors would likely follow. Other domestic spending would be cut about 8 per cent. If carried out for all of 2013, the tax increases and spending cuts would cost the economy about US$670 billion ($815 billion), the CBO estimates.

Will taxes go up?

Probably. Roughly 90 per cent of households would pay more. Middle income households would pay, on average, about US$2000 more, according to the nonpartisan Tax Policy Centre. The top 20 per cent would owe an average of about $14,000 more. Even if Congress delays or blocks the income tax increases, the Social Security tax cut is set to expire. Nearly everyone who gets a pay cheque would receive less take-home pay. This change would cost someone making $50,000 about $1000 a year, or nearly $20 a week.

How bad would it be to go over the cliff?

It depends how long it lasts. If negotiations continue for a few weeks past January 1 and a deal is in sight, it probably wouldn't slow the economy much. Few Americans would expect the tax hikes and spending cuts to last. But if the negotiations collapse and the measures take effect permanently, it could be painful. The stockmarket would likely plunge. Consumers would probably cut spending. Anticipating fewer customers, retailers, restaurants, hotels, vehicle makers and many other companies could cut jobs. And defence contractors and other companies hurt by the drop in government spending would lay off workers. If the tax rises and spending cuts remained in place for a full year, the CBO forecasts that the economy would shrink 0.5 per cent in 2013.

With the budget deficit topping $1 trillion, shouldn't spending cuts and tax increases be welcomed to reduce the red ink?

Most economists favour reducing the deficit. But they'd prefer to phase in spending cuts and tax increases slowly, particularly because the economy is still recovering from recession. The tax increases would be the largest in 60 years as a percentage of the economy. And most budget experts think spending cuts should be targeted and include entitlement programmes such as Medicare and Social Security, rather than indiscriminate across-the-board cuts.

- Agencies

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