Markets hold their breath on the brink
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.
Frequently Asked Questions about this Article…
The fiscal cliff refers to a package of tax increases and automatic spending cuts scheduled to kick in around January that could remove more than US$600 billion of stimulus. The article explains that if no deal is reached, most Americans would face higher taxes, big spending cuts would begin and confidence in the global economy could be undermined — all of which can move markets and affect investor portfolios.
The article reports US stocks fell as talks stalled: the Dow finished about 1.2% lower at 12,938.11 and the S&P 500 lost about 1.1% to 1,402.43. By contrast Australia’s S&P/ASX 200 closed 23.3 points (0.5%) higher at 4,671.3. Commentators in the story warned that short-term uncertainty would continue to influence markets.
According to the article, payroll taxes would rise from 4.2% to 6.2% on January 1 (estimated to cost US workers about US$115 billion over a year). Nearly 90% of Americans would see taxes rise, extended unemployment benefits for around 2 million people would expire, and higher taxes under the healthcare law would affect high earners and some capital gains, gifts and estates.
The article states the US debt ceiling was due to be hit at US$16.4 trillion on New Year’s Eve. When that happens the US Treasury uses "extraordinary measures" — temporary accounting and cash-management steps — to cover about US$200 billion of deficits into 2013, which the article says would typically last roughly two months.
Sequestration is the automatic set of domestic and military spending cuts. The article says about US$110 billion in sequestration cuts would begin on January 2 if no agreement is reached to avoid them.
Yes. The article notes Standard & Poor’s downgraded the US last year from AAA to AA+, while Moody’s still had a top rating. Deutsche Bank’s head of Australian credit research, Gus Medeiros, said the likelihood of a negative rating action had "increased materially" if a last‑minute agreement failed. A ratings downgrade can raise borrowing costs and add volatility to markets that investors should watch.
Treasurer Wayne Swan warned in the article that US gridlock could undermine confidence in the global economy, which could put pressure on activity in Australia and ultimately affect the budget position. The article implies Australian markets and investors are exposed to global sentiment if the US situation weakens growth confidence.
The article lists a sequence of dates: December 31 — US hits the US$16.4 trillion debt ceiling and Treasury begins extraordinary measures; January 1 — payroll tax increase and other tax/benefit changes take effect; January 2 — automatic sequestration cuts start; mid‑February to early March — Treasury may run out of extraordinary measures and be unable to meet obligations if the debt ceiling isn’t raised; March 27 — financing for some federal programs expires. Investors watching market risk should track these milestones.
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