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The two themes that have dominated trading in recent weeks – uncertainty over the US fiscal cliff and the prospect of further economic stimulus measures in Japan – remained the key drivers of market action on Wednesday.
In the US, news that Barack Obama would cut short a holiday in Hawaii to return to Washington for last-ditch budget negotiations with Congress initially offered support to US equities.
But those early gains evaporated as investors increasingly appeared to take the view that a deal was unlikely to be reached before the end of the year to avert growth-sapping tax rises and spending cuts.
Optimism was severely undermined last week when John Boehner, the Republican House leader, failed to gain support from his own party for a draft bill designed to provide an alternative to measures initiated by Mr Obama.
In a recent note, Tom Porcelli, chief US economist at RBC Capital Markets, warned that political gamesmanship appeared quite likely to remain in place until the end of the year.
“We have long said that the real question was not ‘if’ we go over the cliff, but rather to what degree the cliff hits,” Mr Porcelli said.
“At present, our 2013 economic projections include taxes rising on the wealthy and the payroll tax holiday lapsing. If those materialise, we believe first-quarter growth will clock in at just 1 per cent.”
By midday in New York, the S&P 500 index was down 0.6 per cent. Wall Street’s retreat came in spite of further positive news on the US housing market. Data from S&P/Case Shill showed that house prices in 20 US metropolitan areas had risen by a seasonally-adjusted 0.7 per cent in October, more than economists had expected.
“Overall, the S&P Case-Shiller data are consistent with others that show a broad-based increase in housing activity and prices across the country,” said Dean Maki, economist at Barclays.
“We expect this housing recovery to continue in the coming months.”
In the absence of European markets – which enjoyed a further day’s holiday – Japan provided a focus as Shinzo Abe was sworn in as Japan’s prime minister following an emphatic election victory for his Liberal Democrat party.
He said his government’s mission was to restore a strong economy and he has pledged aggressive monetary easing by the Bank of Japan and big fiscal spending by the government to overcome deflation and weaken the yen.
The Nikkei 225 Average in Tokyo extended its recent strong run by another 1.5 per cent to close at a nine-month high, bolstered by gains for export-oriented stocks.
Those gains came as the yen struck a fresh 20-month low against the dollar. The Japanese currency also remained weak against the euro.
However, some analysts highlighted that Mr Abe’s stance risked reigniting global “currency wars”,
“To date, Japan has been conducting defensive policies when it comes to foreign exchange by limiting yen strength as opposed to pursuing yen weakness,” noted Divyang Shah, global strategist at IFR Markets.
“But prime minister Abe seems willing to change this and potentially increase FX tensions and currency war rhetoric in general during 2013.”
The dollar rose as high as Y85.56, while the euro reached Y113.31.
Japanese government bonds fell back on expectations of further policy easing, with the yield on the benchmark 10-year JGB rising 2 basis points to 0.785 per cent. By contrast, US Treasuries attracted demand as fiscal cliff uncertainty continued to dominate. The 10-year yield fell 3bp to 1.75 per cent.
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