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Equities and corporate bonds have registered solid gains so far this year after a last-minute deal over the fiscal cliff was formalised at the start of January. Whether this sense of relief across markets can continue depends largely on whether the administration and Congress can agree to raising the $16.4tn federal debt ceiling and address near- and long-term spending in the coming months.
One scenario that markets do not want to see repeated is the protracted haggling that marked the raising of the debt ceiling in August 2011, which was followed by the US losing its triple-A credit rating from Standard & Poor's and sharp losses for equities.
For now markets appear relaxed about the overall size of the deficit, but that could change.
"Washington seems to be making very little progress closing the budget deficit and that is not a sustainable long-term policy," says Michael Kastner, principal at Halyard Asset Management. "I can't say I'm optimistic about the next four years when long-term deficits are being glossed over."
Investors want Washington to provide a clearer picture over spending and then get out of the way. This would allow the economy to continue its slow recovery of recent years, with consumers and companies gaining confidence, all backed by the Federal Reserve keeping interest rates at their lowest level since the second world war.
"The hope among investors is that the political wrangling passes and that any fiscal tightening does not impede a slowly recovering economy," says John Briggs, strategist at RBS Securities.
Bill Miller, manager of the Legg Mason Opportunity Trust, and one of the most successful stock-pickers of all time, is optimistic on the outlook for the US economy, barring any accidents caused by congressional fighting over the debt ceiling or spending plans.
"If politicians took an oath not to do any harm, that would be a plus," he says.
He adds that the second term for the president may well come to be viewed as far more successful than the first, "at least economically". He adds: "There'll be a big battle over entitlements, but the deficit is falling and this year will be the lowest level in five years." The ratio of debt to gross domestic product looks set to be stable for at least the next six years.
Source: Financial Times | Michael Mackenzie and Dan McCrum in New York