US fiscal cliff deal sends strong risk-on signal
The deal to avert a fiscal cliff in the US is a 'risk-on' signal for emerging markets, but analysts warn about future dangers
Asian stock markets hit a 5-month high, European shares jumped at the open and the traditional safe-haven currencies, the dollar and the yen, fell on the first day of trading of 2013 after news that the US Congress finally reached a deal on averting automatic tax rises that would drag the US economy back into a recession.
"The new year starts with a strong risk-on green light," Benoit Anne, head of emerging markets strategy at Societe Generale, said.
"In the US, the worst-case scenario has been averted with a last-minute deal on a fiscal package, thereby providing massive relief to global risk appetite."
On Tuesday, the House of Representatives approved a bill that extended the tax cuts made in 2001 by President George W. Bush for individuals earning below $400,000 a year or households earning below $450,000. The bill was approved by the Senate on Monday.
The bill also extended unemployment insurance benefits for 2 million people for one year and extended child tax credit, earned income tax credit and tuition tax credit for 5 years.
It also postponed by 2 months the start of $1.2 trillion worth of automatic spending cuts over 10 years and pledged to raise $600 billion in additional revenue over 10 years through some tax increases for the wealthy.
Global markets had been see-sawing on fears that a deal would not be reached on time and the world's biggest economy would fall into recession, dragging other big economies down.
UNCERTAINTY STILL HIGH
But analysts warn that the current market enthusiasm will not last, as the deal is just a temporary fix.
Danske Bank's senior analyst Morten Helt pointed out that even though the agreement avoided "most of the immediate pain," it did not include the thorny issue of raising the debt ceiling or any longer-term budget cuts, which have to be negotiated in February or March.
"Hence, political uncertainty is set to remain high and is likely to weigh on risk markets in the coming months," Helt said in a market note.
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"The fraught political negotiations again highlight that there is still a high risk of a more unfavourable outcome emerging, with the odds of a grand bargain being reached to put in place a more credible long-term fiscal consolidation having also decreased, increasing the likelihood of another US downgrade from the credit ratings agencies ahead," Hardman said.
But overall the deal is positive for the US economy and some analysts say that despite its shortfalls, it removes some of the uncertainty which has plagued the last half of 2012 and signals a better year ahead.
"Our call for growth to accelerate in 2013 counts on a boost to confidence from reduced policy uncertainty," Jim O'Sullivan, an analyst at High Frequency Economics, wrote in a market note.
"That assumption still looks right to us, with the caveat that policymakers have yet to deal with the debt limit."