It’s not the failure to reach a deal on deficit reduction that most worries investors about the breakdown on the supercommittee, analysts say. It’s the fear that political paralysis will affect two other issues that supercommittee members had been discussing: the looming expiration of payroll tax deductions and extended jobless benefits.
Payroll taxes on almost all American workers are poised to rise starting Jan. 1 absent congressional action. A temporary two-percentage-point cut in Social Security taxes increased the average household’s after-tax pay by more than $900 this year, according to the Tax Policy Center, meaning that if the tax cut is not extended, paychecks will shrink starting in the new year. That could undermine consumer spending at a time when turmoil in Europe is already threatening a weak U.S. economy.
President Obama and congressional Democrats advocate keeping the tax cut in place for an additional year, as well as extending unemployment insurance benefits. Many Republicans are resistant to measures that would widen the deficit further, though leaders of the Republican-led House haven’t ruled out a deal entirely.
In Europe, the crisis confronting cash-strapped governments continues to expand, outstripping the efforts of political leaders to muster a forceful response. European leaders had hoped last month to snuff out the continent’s financial contagion with a new rescue program before the troubles spread to major economies.
But global investors have not been persuaded by the emergency response, which remains a work in progress and short of funding. As a result, borrowing costs for several countries, including Italy and Spain, have spiked to potentially unsustainable levels — raising the prospect of devastating defaults — and doubts have surfaced about the creditworthiness of France, Europe’s second-largest economy.
On Monday, the Dow Jones industrial average fell 248.85 points, or 2.1 percent, and the broader Standard & Poor’s 500-stock index was down 1.9 percent. The German Dax index was off 3.4 percent, and French and Spanish markets dropped by similar amounts. Asian markets were lower in early trading Tuesday, but only slightly. Japan’s Nikkei 225 index closed the morning session down only .13 percent.
Reflecting fears over economic growth, investors plowed money into what they considered havens, including government bonds issued by the United States, Britain and Germany. The 10-year Treasury bond yielded 1.96 percent Monday, down from 2.01 percent Friday. That suggests that the breakdown of the supercommittee talks did not trigger heightened fears about the U.S. government’s financial situation, as investors were willing to lend the federal government money more cheaply on Monday than they were on Friday.