WASHINGTON -- Over the past month, financial investors and speculators have largely shrugged off federal lawmakers' inability to avert the so-called fiscal cliff, despite loud warnings in Beltway circles that failure to reach a deal would cause economic calamity. Although markets have seen some modest hiccups, stock prices have been roughly flat for December, preserving the steady gains of the previous 11 months of 2012.
The reaction to U.S. Treasury bonds has been similarly muted. On Thursday, the interest rate on 10-year bonds was 1.74 percent, up slightly from 1.62 percent at the beginning of the month. The interest rate on Treasury bonds measures how risky investors perceive American debt to be. High rates mean investors believe the debt to be risky, and are demanding greater return for their money. Low rates mean investors think the debt is safe. So far, lawmakers' failure to reach a deal has not caused a crisis of investor confidence in the government's ability to pay its bills.
Stock and bond markets can be both finicky and prone to panic, and it's always possible that failure to reach a deal could result in a sudden market drop. Stock prices on Friday were down a little over 0.5 percent in early trading. But even a major plunge would be unlikely to reverse what has been a robust year for stocks and one of the most inexpensive years in history for the U.S. government to borrow money.
Over the course of 2012, interest rates have fallen slightly for U.S. debt, with the 10-year bonds opening the year at 1.89 percent, and dipping below 1.40 percent during the summer, a record low. During the presidency of George H.W. Bush, the rate regularly exceeded 9 percent, and rarely fell below 5 percent during Bill Clinton's reign.
The Dow Jones Industrial Average has had a strong year, climbing roughly 6.5 percent, trading at around 13,000 early on Friday after ringing in 2012 at 12,217.56. The S&P 500, another leading index fund, has had a banner year, surging over 12 percent. Like the Dow, the S&P 500 has had some modest ups and downs during December, but has been flat overall in the final month of negotiations to avert the fiscal cliff.
The U.S. has weathered a handful of heated legislative standoffs ahead of major economic deadlines in recent years. But unlike the 2011 debt ceiling talks, no immediate disaster will take place on Jan. 1 if lawmakers cannot come to an agreement to avoid going over the fiscal cliff. Failing to raise the debt ceiling would have forced the U.S. to default, which would have caused major international financial upheaval -- every major nation and investment firm has holdings in U.S. Treasury bonds.
On Jan. 1, by contrast, a new set of spending cuts and tax policies will go into effect. Over the course of several weeks or months, the cumulative effect of those new policies would take a toll on economic growth -- but there would be no immediate economic shock.
That could change if Congress fails to raise the debt ceiling, however. Treasury Secretary Timothy Geithner wrote a letter to lawmakers this week indicating that the nation would hit the debt limit on New Year's Eve, but that a series of technical maneuverings by the Treasury Department would keep the government from officially breaching it for a few weeks. Geithner said the total time was hard to predict, but that under normal circumstances, these extraordinary measures would buy about two months.As investors look ahead to that deadline, they may well become skittish, and market movements could become much more dramatic.