Cliff averted, but confrontation looms

Investors breathed a sigh of relief on new year’s day with the passage of the hastily-negotiated fiscal cliff bill, and BMO Private Bank expects interest rates to remain stable until lawmakers get back to the table next month.

The anticipated fiscal cliff consisted of $600 billion in automatic spending cuts and tax increases that were set to go into effect in early 2013. Without the agreement, they likely would have had a negative impact on U.S. economic growth and a ripple effect around the world.

Read: Fiscal cliff bill subsidizes Wall Street

“The House approval of the Senate bill was a big win for President Obama, who pledged to raise taxes on higher income earners,” says Jack Ablin, chief investment officer, BMO Private Bank. “Surprisingly, there were virtually no spending cuts included in the compromise.”

Ablin noted the most difficult decisions will take place in late February, including the sequestering of automatic spending cuts amounting to more than $100 billion per year. He also said the return of the debt ceiling debate would dominate news headlines in the coming weeks.

Read: Fiscal cliff FAQ

The last-minute negotiations this week resulted in the following:

• Individuals making more than $400,000 or couples earning more than $450,000 USD (0.7% of U.S. households) will see the top marginal income tax rate rise to 39.6% in 2013, up from 35% last year
• Tax rates for income earned below those thresholds have been extended
• Investment-related tax rates increased
• Taxes on long-term capital gains and dividends increased to 20% from 15% on high-income households
• Taking the new 3.8% Affordable Care Act tax into account, the new effective rate rises to 23.8% for those filers
• Congress extended the $5-million estate tax exemption, raising the tax rate from 35% to 40%

In addition, Congress allowed Federal Insurance Contributions Act (FICA) taxes to rise by two percentage points for all Americans. BMO estimates that the payroll tax will take roughly 2% out of consumer spending in the first quarter of 2013.

Read: Goldman execs skirt higher cliff taxes

“Investors may be celebrating, but the bond market isn’t too happy,” Ablin says. “As it stands now, the deal sets the stage for roughly $3.6 trillion of additional deficits over the next 10 years. The 30-year treasury yield just broke above 3%, its highest level in months. While we do not expect a dramatic rise in interest rates, inaction by Washington could be a cause for concern for bond holders.”

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.