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Markets rally on fiscal cliff agreement but a second chapter waits in February

Wednesday, January 2nd 2013 - 23:39 UTC
Full article 8 comments
President Obama managed some of his goals: higher taxes on the rich   President Obama managed some of his goals: higher taxes on the rich

Global stock markets have rallied after a short-term deal to stave off the US “fiscal cliff” was reached. In New York, the Dow Jones closed up 2.4%, while European shares were up about 2% for the day.

Failure to agree a deal would have triggered spending cuts and tax rises worth 600bn dollars, expected to throw the US back into recession. However, the deal has only postponed by two months negotiations over spending cuts and the government debt ceiling.

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.

The fiscal cliff deal does not include an increase in the debt ceiling. It also postpones by two months steep automatic spending cuts to federal government spending on things like defence and education.

International Monetary Fund spokesman Gerry Rice said in a statement that “more remains to be done”, although he expressed relief that at least the tax hikes, which had threatened to send the US economy into recession, had been averted.

The fiscal cliff measures - 536bn of tax rises and 109bn of spending cuts - had been due to come into effect at midnight on Monday.

The deal has averted most of these, including:

• making tax cuts that date back to George W Bush's presidency permanent for individuals earning less than 400.000
• postponing 65bn of automatic spending cuts for two months
• keeping benefits for the long-term unemployed, worth 26bn, available for another year
• postponing for a year an 11bn cut in Medicare payments

However, the deal also allowed some tax rises to go ahead:

• the expiry of a payroll tax holiday, expected to raise 95bn in additional annual revenue
• allowing the Bush-era income tax cuts for individuals earning over 400.000 to come to an end, with the top rate increasing from 35% to 40%
• higher taxes on dividend income, capital gains and inheritance for these same top earners
• phasing out certain income tax deductions for individuals earning more than 200.000

The US recovery has been gaining momentum since the summer, with jobs growth accelerating and the housing market turning the corner. Economists had feared that it would be knocked off course if the fiscal cliff went ahead in full.

The latest economic data released on Wednesday showed that activity in the US manufacturing sector began expanding again in December, according to the latest monthly survey by the Institute for Supply Management. However, the rate of expansion was weak, with many businesses postponing investment decisions due to uncertainty over the fiscal cliff.

The fiscal cliff deal has postponed the hardest decisions that Republican and Democratic politicians must still reach agreement on-over spending cuts and the debt ceiling.

Both issues will need to be addressed at the end of February, with Republicans likely to demand deep cuts, particularly to entitlement programmes such as social security, in return for an increase in the legal cap on government borrowing.

Entitlement payments are expected to rise sharply in the coming decades as the post-World War II baby-boom generation retires and enters old age, entailing more government-funded medical care.

President Obama's Democrats would prefer to reduce the government's deficit via further tax rises.

Despite the deal's shortcomings, markets took cheer from the fact that agreement had been reached on how to postpone and moderate the process of bringing the government's overspending back under control.

The FTSE 100 index ended Wednesday up 130 points at 6,027 points, the first time it has been above the 6,000 level in 17 months, with mining shares leading the way.

Shares worldwide had been hurt in November and December by fears that the US would not be able to reach any kind of agreement and would go off the cliff.

Categories: Economy, Politics, United States.

Top Comments

Disclaimer & comment rules
  • Anglotino

    The US government seems to only work when it is in crisis mode.

    The simple fact is that higher earners can and should pay more tax.

    Jan 03rd, 2013 - 12:32 am 0
  • Rufus

    Agreed, roll on Fiscal Cliff 2 in a couple of months time.

    Presumably with Son of Fiscal Cliff and Revenge of the Cliff in four and six months respectively. Is it any wonder that the credit rating agencies view the US as unstable when it's this prone to almost dissapear up it's own backside only to reach a last-minute solution that has a two month lifespan.

    Jan 03rd, 2013 - 10:02 am 0
  • Condorito

    I read that George Lucas is already planning an epic opera franchise:

    A New Cliff
    Cliff Strikes Back
    Return of the Cliff
    The Phantom Cliff
    Attack of the Cliff
    Revenge of the Cliff
    The Cliff Wars

    Jan 03rd, 2013 - 02:30 pm 0
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