US Averts Fiscal Cliff

The US lawmakers gave the world a new year present by agreeing to avoid the fiscal cliff. Unable to resolve the issue last year (2012), the US lawmakers worked late on the first day of the new year to approve, by a vote of 257 to 167, the deal that helped it to avoid tottering over the fiscal cliff.

Fiscal cliff, a term coined by Federal Reserve Chairman Ben Bernanke, describes a situation where the simultaneous tax hikes and spending cut in the US would have saved around USD 600 billion of the US economy every year that was enough to push it into a recession. It has been nothing short of a rollercoaster ride so far, with lots of twists and turns seen in the last one month.

The consequences of not reaching a deal to avert this would have been disastrous not only for the US economy but for the world economy too, as the Euro zone is shrinking and Chinese economy is limping. Therefore, the US economy slipping into recession would have pulled down world economic growth.

We believe that the deal will help the risk assets to attract more money going forward. Therefore, emerging markets and commodities will be benefit from the deal.

Some key features of the deal:

• Tax hike applicable only to those who earn more than USD 400000 per annum for individuals and USD 450000 for families. For others, the tax rates will be same as earlier.
• Rise in capital taxes up to 20%.
• Extension of unemployment benefits for one year.
• Five year extension for tax credits.

However, although the deal has resolved the issue of tax hikes, it has only delayed the spending cuts. It is expected that in next two months, when the US economy will be approaching its debt ceiling limit, it will again open a new window of volatility.

In 2011, which was the last time when the US Congress approved an increase in the US debt ceiling after its own share of political battle, we had seen the first ever downgrading of the US credit rating. Now, with the situation as it stands, we could see the market going haywire once again.