The City warns the US over kicking the fiscal cliff down the road

Analysts at investment houses in the City of London were surprised the Republican Party appeared to have softened its posturing against any deal with the Democrats over the US fiscal policy. In this week’s notes, most described it, though, as a short-sighted agreement with the Obama administration to avoid a sudden and automatic spike of taxes–known as fiscal cliff–and some British fund managers alerted that the absence of a stable accord would curb today’s optimism.

“The euphoric equity gains are likely to be very short lived and significantly were not mirrored by the currency market where the US Dollar has failed to strengthen in the wake of the deal,” said Jason Gaywood, director at foreign currency exchange brokers HiFX. “The danger is far from over,” Gaywood warned.

HiFX sent a tough message to the Republicans: “The dangerous game of brinkmanship played by the Republicans in delaying any accord and the fact that the eventual agreement amounted to little more than papering over the cracks are both worrying signs that the US economy is in as big a mess as its EU counterpart. Toppling over the ‘fiscal cliff’ has by no means been averted in 2013 because all Senate and the House of Representatives have done is ‘kick the can down the road’ in much the same way as Obama criticised EU leaders for doing over here in 2012.”

The figures don’t look too good. “Raising taxes on the rich and simply delaying spending cuts for a paltry two months are going to do little to remedy the humongous US debt problem which amounts to over $17 trillion.”

Cormac Weldon, head of US Equities at Threadneedle criticised the stiff relationship between the two main political parties. “Given the partisan political structure we are glad that the deal was done on Tuesday.” But Weldon qualified the outcome as merely “reasonable”.

The majority of the tax increases “are for the wealthy” and shouldn’t impact consumption within the economy as “the last dollar someone on $450,000 earns is generally saved and not spent,” Threadneedle explained. “However the 2% increase in payroll taxes will impact everyone therefore we expect to see slightly less spending, or at least a constraint in spending growth, this year.”

Weldon added that those heralding the bipartisan deal as a success should be reminded of the delay in the pact on spending cuts, “the so called ‘sequestration’. This has been pushed out by a couple of months and will be debated at the same time as an extension of the debt ceiling. This will be the main part of the fiscal cliff resolution, and the political debate that we have seen regarding tax increases is small in relation to what we are about to see.”

At JP Morgan, global strategist Dan Morris highlighted the Republican U-turn: “The biggest surprise about the (temporary) resolution of the fiscal cliff dilemma was the strength of Republican party support: 85 votes in the House of Representatives and 40 in the Senate, despite previous pledges by many to never vote for a tax increase.”

For JP Morgan, the tax increases subscribed by both parties will not resolve the country’s deficit and cuts will have to be made in order to bring expenditures closer in line with revenues. The next two months “will continue to provide political drama,” but should be less significant for the markets as any cuts will be implemented only slowly.

“The extension of unemployment benefits for another year will help support domestic demand,” Morris said. Consensus estimates for GDP growth point at just 2%.