Global shares up on hopes U.S. to avoid "fiscal cliff"

Wall Street rallied on Monday and global equities headed for their best year in the last three as U.S. lawmakers closed in on a deal to avoid a budget crisis that many fear could cripple the world economy in 2013.

U.S. President Barack Obama said Congress was close to an agreement that would start chipping away at the deficit without raising middle class taxes.

Senate Republican leader Mitch McConnell also said agreement was "very, very close."

U.S. stocks rose, capping off a strong year on a high note and leaving the MSCI all-world index on track to end the year up 13 percent. U.S. government debt prices fell.

The deal is not likely to provide a long-term road map to reduce the U.S. budget deficit, which has been above $1 trillion for four straight years.

But without it, $600 billion of automatic spending cuts and across-the-board tax increases would take effect January 1, a blast of austerity that economists fear would thrust the United States into recession and hurt world growth.

"Traders understand that this is a stop-gap measure, but they'll take it," said Quincy Krosby, market strategist at Prudential Financial in Newark. "Markets can rally with some growth, but not with no growth. For now, they don't mind kicking the can down the road."

The Dow Jones industrial average was up 150.93 points, or 1.17 percent, at 13,089.04. The Standard & Poor's 500 Index was up 21.80 points, or 1.55 percent, at 1,424.23. The Nasdaq Composite Index was up 59.94 points, or 2.02 percent, at 3,020.25.

European shares also gained after a quiet day in Asia, where Japan's Nikkei and other indexes were already closed for 2012.

Despite recent declines on Wall Street and what seemed like a hopeless stalemate in budget talks, the benchmark S&P 500 was up 12.5 percent in 2012 after a nearly flat performance the prior year. The Dow was up 6 percent and the Nasdaq 15 percent.

With the world's major central banks expected to keep pumping stimulus into their economies at any sign of weakness, most economists forecast further gains in equities next year.

Benchmark 10-year U.S. Treasuries fell 16/32 on the pending fiscal cliff deal to yield 1.76 percent. Treasury yields finished the year only slightly above where they started it, thanks to heavy safe-haven buying and the Fed's asset purchase programs aimed at keeping long-term rates low.

STILL RISKS AHEAD

Risks still remain for 2013, investors said.

Europe could lurch back into trouble if slow growth puts further pressure on heavily indebted countries such as Spain and Italy, said Alan Wilde, who helps manage $50 billion at Baring Asset Management in London.

"This pressure point may make acceptance of austere policy measures unpalatable and politicians may find they have to find other ways to cut costs," he said.

In the United States, striking the right balance between growth and deficit reduction will also be a challenge, as will addressing long-term fiscal problems.

"It looks to be another lengthy time of instability and volatility on Wall Street as the real work to address the longer term fiscal health of the U.S. government moves into 2013," said Ron Florance, managing director of investment strategy at Wells Fargo Private Bank.

But in 2012, investors worst fears -- a euro zone collapse, a hard landing in China's once-booming economy and another U.S. recession -- never came to pass.

The pan-European FTSEurofirst 300 gained roughly 13 percent this year, largely due to the European Central Bank's vow to tackle the region's debt crisis, and recovered from an early morning dip to end the year at 1,131.64.

Peripheral euro zone bonds also rallied after a roller coaster year. Yields on Spanish and Italian sovereign bonds, a measure of the compensation creditors demand for lending to those governments money, spiked in the summer but have since fallen sharply. Euro zone bond markets were closed on Monday.

The euro was down 0.2 percent at $1.3191 but was up 2 percent for the year. An agreement on the U.S. budget would also be viewed as positive for the euro because it would help boost global growth.

Against the yen, the dollar hit 86.64, its best showing since mid-2010, and was set to end the year 12 percent firmer against Japan's currency, its biggest gain since 2005.

With a new Japanese government led by Prime Minister Shinzo Abe expected to pursue a policy mix of aggressive monetary easing and heavy fiscal spending to beat deflation, analysts see the yen staying under pressure in 2013.

Commodities also found recent support as economic data in key emerging economies such as China have started pointing to a gradual pick-up in the pace of growth in 2013.

Gold was $1,675.60 an ounce, up more than 6 percent for the year and on track for a 12th consecutive year of gains. Rock-bottom interest rates, concerns over the financial stability of the euro zone, and diversification into bullion by central banks have boosted the metal. Copper also rose, ended the year up 6 percent after a late rally on Monday.

U.S. crude rose 96 cents to $91.76 per barrel but ended 2012 down more than 7 percent.

(Editing by Chizu Nomiyama and Kenneth Barry)