Hopes For Fiscal Cliff Solution Fade As Time Runs Out

Hopes for a solution to the Fiscal Cliff fade as time is running out. The likelihood of a temporary fall over the Cliff has risen and it seems increasingly unlikely that a "mega deal," which includes a solution to the immediate Fiscal Cliff issue for 2013, a framework for spending cuts over the coming decade and an increase of the debt ceiling, will be reached.

US law makers will resume negotiations today and yesterday the White House announced that President Barack Obama will cut short his Christmas break and return to Washington to make a final effort to solve the Fiscal Cliff crisis. Both parties do not have any interest in not reaching a deal as this will cause an immediate fiscal blow to US households as income taxes will increase.

There is still time to reach an agreement but at this stage a more likely scenario is that we will get a "mini deal," which is likely to include an extension of the Bush tax cuts for the majority of the American households and indexing the AMT for inflation. The deal will probably not tackle the debt ceiling and hence political uncertainty is set to remain high and will weigh on risk markets next year.

US equities fell for the third consecutive day in a market with low trading volumes. The S&P 500 index closed 0.5% lower, while Dow Jones Industrial Average dropped 0.2%. In Asia most regional equity indices trades higher this morning with Nikkei and Topix in the lead (both are currently up by 1%) ahead of tomorrow’s long series of Japanese data releases, including core CPI and industrial production.

The yen dropped to the lowest level in 27 months versus USD this morning and USD/JPY is currently trading around the 85.80 levels, as the market speculates that Japan tomorrow will report a decline in its core consumer prices, supporting the newly-installed Prime Minister, Shinzo Abe’s, case for more aggressive monetary actions.

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