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.
The committee’s failure did little to alter analysts’ fundamental views about the U.S. government’s financial position. The rating firm Standard & Poor’s, which in August downgraded the credit rating of the United States after a turbulent impasse over raising the federal debt ceiling, said in a statement Monday afternoon that it was not adjusting its rating or outlook in response to the breakdown in the committee’s negotiations.
“If you add up what’s going on in terms of the supercommittee’s failures and what’s going on in Europe, it all tilts toward austerity and cutting the legs of support out of the economy going forward,” said Steve Blitz, senior economist at ITG Investment Research. “The inability to get anything done reflects poorly on the ability to get any kind of political cohesion to do something to help the economy in the next year.”
Economists at J.P. Morgan Chase estimate that a failure to extend the payroll tax reduction and unemployment insurance benefits would subtract 1.5 to 2 percent from 2012 growth in gross domestic product.
“The question now is whether politicians can still come together and get these extended, in what is likely to be a poisonous atmosphere as each side blames the other for the supercommittee’s failure,” said Nigel Gault, chief U.S. economist for IHS Global Insight.
U.S. markets dropped despite some good news about the economy, the latest in a string of better-than-expected indicators. The National Association of Realtors said existing-home sales rose 1.4 percent in October, to an annual rate of 4.97 million. Analysts had expected the number to decline.
Last week, reports on October retail sales, industrial production and housing permits were also positive, suggesting that the economy is firming despite the headwinds from fiscal policy and recent financial turbulence.
In Europe, meanwhile, investor attention pivoted to Spain after weeks of focusing on Greece and Italy. Spain’s ruling Socialist Party lost big in parliamentary elections over the weekend, which is sweeping Prime Minister Jose Luis Rodriguez Zapatero from office. The new governing center-right Popular Party, led by Mariano Rajoy, will now face the arduous task of enacting budget cuts and other reforms.
Investors aren’t making it any easier: The cost Spain must pay to borrow money for a decade rose by 0.17 percentage points Monday, to 6.48 percent, reflecting concerns that Rajoy’s government will be less aggressive than its predecessor in taking action.
It follows a week in which fears spread beyond the five nations where they have been concentrated for more than a year to nations perceived as safe. Last week, bond yields rose sharply in France, Austria, Belgium and Finland, nations with generally sound finances, a sign global investors are becoming more fearful about even “core” European nations.
Staff writer Jia Lynn Yang contributed to this report.