Markets hold their breath on the brink

FINANCIAL markets are holding out for breathing room as the final negotiations take place in the United States over the looming so-called fiscal cliff, even though the critical year-end deadline is expected to be missed by midnight.

Strategists are hoping for a timeline to spill over into January as the White House and Senate enter intense last-minute talks to try to reach an agreement that would prevent more than $US600 billion in tax hikes from taking effect.

Even so, Treasurer Wayne Swan warned that the gridlock in the US talks can undermine confidence in the global economy. This could put further pressure on activity here and ultimately on Australia's budget position if the economy slows, a spokesman for Mr Swan said.

"While in Australia we have very low debt and strong public finances, we cannot pretend that we're immune from these developments either," the spokesman said.

The US government will hit the $US16.4 trillion limit on New Year's Eve and the US Treasury will begin using extraordinary measures to finance about $200 billion of deficits into 2013. That would typically be enough to last about two months.

If no deal is done, nearly 90 per cent of Americans will see their taxes rise on January 1, a wave of deep spending cuts will start to take effect, and 2 million long-term unemployed people will lose their benefits.

US stocks were down on Friday, amid growing fears that an agreement on the debt deal was unlikely.

UBS head of investment strategy George Boubouras said the next best thing to an agreement between the White House and Congress would be a plan going into the new year. "Every word and every statement will be scrutinised and will impact markets in the short term," Mr Boubouras said.

"As long as there is a reference to a timeline into January and February that addresses the varied components of the fiscal cliff, that would be enough for the market," he said.

But he cautioned that markets would likely suffer from some uncertainty in the short term.

Others said there was risk of another US ratings downgrade if a last-minute agreement failed.

Standard & Poor's lowered its US credit rating for the first time last year - from AAA to AA+ - when politicians struggled to meet a deadline to raise the country's debt ceiling. Moody's currently has the US at its highest rating of "Aaa".

"In our view the likelihood of a negative rating action on the US sovereign rating has increased materially," said the head of Australian credit research at Deutsche Bank, Gus Medeiros.

US stocks were traded lower for most of the day on Friday amid uncertainty about last-minute negotiations in the White House.

The Dow Jones Industrial Average finished 1.2 per cent lower at 12,938.11, while the broad market S&P 500 lost 1.1 per cent to 1402.43. Australia's benchmark S&P/ASX200 Index ended Friday 23.3 points, or 0.5 per cent, higher at 4671.3 points.

US senators entered a weekend of budget negotiations in a final effort to prevent hundreds of billions in tax-dollar increases and spending cuts from taking effect through January.

"The hour for immediate action is here," President Barack Obama said at the weekend at the White House, adding that he was "modestly optimistic" about a deal, while complaining about Congress's tendency to wait until the last minute to act.

Beyond extension of the tax cuts set to expire and expanded unemployment insurance, senators will consider provisions to prevent a reduction in Medicare payments to doctors, avoid some automatic spending cuts and prevent a scheduled increase in milk prices.

Any agreement is unlikely to raise the federal debt limit, which is almost at its ceiling.

If Senate leaders can't agree on a bill, Mr Obama said he will ask the Senate to vote on a plan he outlined before Christmas that would let taxes rise on annual household income exceeding US$250,000.

As the deadline nears, the potential scope of a deal is getting narrower. Mr Obama and US House Speaker John Boehner had spent several weeks negotiating towards an agreement that might have included cuts in entitlement programs such as Medicare, a debt-ceiling increase, permanent extensions of miscellaneous tax breaks and language to prevent an expansion of the alternative minimum tax.

The absence of a debt ceiling agreement would make the limit on US borrowing authority the next event forcing debate. Republicans plan to use it as leverage to force Mr Obama to accept spending cuts.

Economist Paul Krugman has argued that going over the cliff will not be so bad, given that there will be weeks, if not months, to repair any economic damage.

But the Business Roundtable representing the CEOs of major US companies counters that the fiscal cliff will damage economic progress made in the past year and should be avoided at all costs.



What happens over the edge

December 31

■The US government debt ceiling is officially reached and US Treasury begins "extraordinary measures" to put off default.

January 1

■Payroll taxes rise to 6.2 per cent from 4.2 per cent, a move estimated to cost American workers $US115 billion over the next year.

■High earners face new taxes under the healthcare law. Capital gains, gifts and estates subject to higher taxes.

■Extended unemployment benefits, worth about $US30 billion, expire for about 2 million people.

■Payments to Medicare providers fall by 27 per cent, reducing the subsidy that is paid to doctors.

January 2

■$US110 billion in automatic domestic and military spending cuts, known as sequestration, begin.

Mid-February to early March

■If the debt ceiling is not raised, Treasury will be unable to meet its financial obligations.

March 27

■Financing for federal programs that rely on budget appropriations from Congress expire.