A split US Republican party has failed to unite behind its own “Plan B” to avoid the so-called “fiscal cliff”. The proposal would have raised taxes on earnings above one million dollars (758,000 euros), but even that tax hike was too much for conservative members.
It is a major setback for House Speaker John Boehner who was hoping to squeeze concessions out of the Democrats once the plan had been approved. Boehner is due to hold a news conference at 16.00 Central European Time.
If no budget reform agreement is reached by the New Year, draconian tax rises and spending cuts will be automatically triggered. The 600 billion dollar package (455 billion euros) could push the world’s biggest economy into recession.
President Barack Obama has promised to go on working with Congress before the “fiscal cliff” deadline but he wants more tax hikes for more better-off Americans than the Republican will accept. The stalemate continues.
Investors stirred, not shaken
Global investors are betting Washington will overcome its budget deadlock.
If they are wrong, there could be a sharp market reaction and the US dollar and Treasury bonds would be among the main beneficiaries, making for a very different dynamic to the eurozone crisis, where bond market pressure was instrumental in forcing policymakers to act.
Jeffrey Rosenberg, chief investment strategist for fixed income at BlackRock, said the only approach was to “hope for the best, but plan for the worst”.
“Given the much greater downside from a fiscal cliff failure than upside from success, we continue to maintain our tactical defensive positioning,” Rosenberg said.
If differences between Republicans and Democrats cannot be bridged, the dollar — counterintuitively to the layman’s eye — would attract safe haven flows as the world’s reserve currency.
The yen could do even better despite the new Japanese government’s intent on more forceful monetary and fiscal easing.
“The dollar goes up when people get more nervous because the reflex in the market is to assume it’s a safe haven, there’s very little consideration given to the nature of the crisis,” said Daragh Maher, FX strategist at HSBC.
“If the US is heading towards recession it’s not good for anyone, therefore if I have to hold something I may as well hold the dollar. That’s how the sequence of logic goes,” Maher said.
US politicians are now in recess until at least Dec. 27.
“The time left to seal a deal is limited,” said Kit Juckes at Societe Generale in London.
There is, however, good reason not to panic since the term “fiscal cliff” is somewhat misleading. America will not crash off it on Jan. 1. The tightening process will be more gradual.
The head of G10 FX Strategy at one bank in London said it was much more of a slope than a cliff. “The market’s working assumption has been all along that it’s going to go right down to the wire, and then they’re going to cut a deal.”
Hong Hao, Bank of Communications International Securities’ chief equity strategist in Hong Kong, said: “If I were a fund manager, I would be looking to lock in gains and going off for the holidays. The US will eventually come to a deal, maybe just not by their self-imposed deadline.”