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Mixed picture of economy could leave the markets too mixed. Chances are more that the futures would trade range-bound in 2013 until definitive moves on raising of debt ceiling and restriction on spending emerge in add..

29 Dec 2012

By Rakesh Neelakandan
Yesterday as one speculated about a prequel deal to fiscal cliff arriving at, going by the words of US President Obama that he is modestly optimistic on fiscal cliff solution, it seems that a patch work deal is all that is possible.

Media reports suggest that Democrat leader Harry Reid of Nevada and Republican leader Mitch McConnel of Kentucky would slog it out together to arrive at a compromise which they may present before their party peers in Congress by Sunday afternoon. If all goes well, then Senate would prepare to vote on the proposal on Monday.

Mitch McConnel said he was "hopeful and optimistic" about the outcome.

The question is how this anticipated patchwork deal would affect the commodity markets.

The point is that markets, sensing the evolving mood may already have priced in the patchwork outcome, if not fully, to an extent. The best indicator is gold.

Futures in gold began to dive from $1662.75 on the Comex in the evening session (Indian time) yesterday to close at $1656.45 in early morning hours as the meeting of leaders discussing fiscal cliff gained momentum. Silver was relatively steady.

It is evident that going off the fiscal cliff would see automated spending cuts and tax hikes jumping on board with a ruck sack worth $600 billion.

At about 3.5% of GDP, the tax hikes would be the largest increase since World War II.

It is also a scenario of highest tax rates getting imposed on individual incomes at a whopping rate of 39.6% since 2000. It is again the scenario of highest tax rates on capital gains at 23.8% since 1997 and the highest tax rate imposed on dividends at 43.4% since 1986.

No wonder, economists are predicting a recession in the first half of 2013, including those at the Federal Reserve and the Congressional Budget Office if US goes off the cliff. 

“Arguably, this would be the first recession created by a tax increase since 1969, or, before that, the Great Depression.”noted taxfoundation.org

It has also to be noted that the patchwork deal may agree only on the following items to the best of our knowledge.

Extending Bush-era tax cuts: The leaders may agree to extend the tax cuts of Bush-era on American households earning below the threshold of $250,000. [The $250,000 celing may actually go up to $450,000.]

Exemption from Alternative Minimum Tax: Some 28 million US people earning between $100,000 and $500,000 a year will have to pay the alternative minimum tax in 2013 for the period of 2012. (The tax was actually targeted at multimillionaires who in turn outmaneuvered the system and managed to stay away from the ambit of tax). The 28 million have pegged their hopes on Congress exempting “them from the tax that they were never intended to pay.”; New York Times had said.

Deferring of across-the-board spending cuts: Many believe that the spending cuts can make US much more vulnerable to security threats and deferring them is necessary.

Will these measures be enough to help markets trade with confidence?

The patchwork deal leaves the case of capital gains tax and dividend tax behind and that can spoil the New Year party. The individual taxes, however may get averted helping consumer spending to maintain satisfactory levels. Deferring of spending cuts, if arrived at would also remain a silver lining. 

However, one has to note that the patchwork deal would not possibly address restricting spending on Social Security and Medicare. The Republicans insist on this aspect. Besides, raising of debt ceiling would also not be addressed leaving the door open to further debates and volatility triggers.

This mixed picture could leave the markets too mixed. Chances are more that the futures would trade range-bound in 2013 until definitive moves on the above-said aspects—debt ceiling and restriction on spending—emerge in addition to the unaddressed issues of capital gains tax and dividend tax. And most of these may not emerge at least until March. 

High volatility would mark the market actions as gold and silver would remain in tenterhooks. Eurozone cues too would swing the markets either ways. (rakesh@commodityonline.com)

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