World week ahead: Can Santa bring a US budget deal?

The focus on this holiday-shortened week on both sides of the Atlantic will remain keenly on the attempts to reach a US budget deal after talks ground to a halt.

There is just one week left to find a compromise acceptable to both Democrats and Republicans and prevent US$600 billion of tax increases and spending cuts that would probably tip the world's largest economy into recession in 2013.

Still, optimism remains that President Barack Obama and House Speaker John Boehner will succeed.

"The markets still basically believe that something will be done," Sandy Lincoln, chief market strategist at BMO Asset Management US in Chicago, told Reuters.

President Obama, too, believes something can still be done.

A plan can be achieved "whether it happens all at once or whether it happens in several different steps," the president said at the White House on Friday, according to Bloomberg News. "Call me a hopeless optimist, but I actually still think we can get it done."

After Boehner's failure to convince his own Republican colleagues to support a tax increase on individuals earning more than US$1 million, President Obama said the Congress should move forward on a narrower agreement that at least held tax rates steady for 98% of Americans, leaving the most politically divisive issues to be debated in the New Year.

US Treasuries received a boost on Friday, however, from the increased suspense.

"There may be a last-minute deal, but there has been a notable increase in risk in the markets," Adrian Miller, director of fixed-income strategies in New York at GMP Securities, told Bloomberg.

The House and Senate are on break until Thursday, perhaps giving both Democrats and Republicans time to rethink their positions.

Data released this week will offer fresh clues on the American housing market, which has shown promising signs of a sustained recovery, through the S&P Case-Schiller Home Price Index on Wednesday, New Home Sales on Thursday, and the Pending Home Sales Index on Friday.

Other reports due in the coming days include Consumer Confidence on Thursday and Chicago PMI on Friday.

Trading volume on Wall Street is expected to be low this holiday-shortened week. Markets close early on Monday and are closed on Tuesday for Christmas Day.

"I'm guessing it's going to be a low volume week. There's not a whole lot other than the fiscal cliff that is going to continue to take the headlines," Joe Bell, senior equity analyst at Schaeffer's Investment Research, in Cincinnati, told Reuters.

In the past five days, the Dow Jones Industrial Average gained 4%, the Standard & Poor's 500 Index rose 1.2% and the Nasdaq Composite Index climbed 1.7%.

Last week, the benchmark Stoxx Europe 600 Index gained 0.6%. Mario Monti, who resigned as Italian prime minister on Friday after parliament approved his government's budget for next year, is expected to clarify his future plans as early as Sunday.

After initially saying he wouldn't run for office, Monti more recently appears to have been in campaign mode. EU leaders are keen for Monti -- or at least the reforms he's initiated -- to remain firmly in place.

Meanwhile, the Japanese yen extended its weakness against the greenback, dropping 0.9% for the week to ¥84.24 per US dollar, as the newly-elected Shinzo Abe and his Liberal Democratic Party raised the spectre of further monetary easing.

"We are eventually heading toward 100 in [US] dollar-yen and maybe the other side of it -- that's how significant this sea change in Japan is," Andrew Wilkinson, chief economic strategist at Miller Tabak in New York, told Bloomberg.

"People will still believe that something has to give with the fiscal-cliff debate. I am still banking on strong US growth next year."

(BusinessDesk)