U.S. stocks edged up on Monday and global equities prepared to wrap up a strong year as U.S. lawmakers held last-minute talks to avoid a budget crisis that many fear could cripple the world economy in 2013.
Traders still at their desks on the last day of the year were focused on talks in Washington, where politicians were trying to agree on a deal that would prevent $600 billion of tax increases and spending cuts from taking effect in January.
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Economists fear such a blast of fiscal austerity could shrink output in the world's biggest economy by about 4 percent, which would threaten a fragile global recovery.
Senate Majority Leader Harry Reid said lawmakers would renew talks at 11 a.m. Washington time (1600 GMT) but said there were still significant differences between Democrats and Republicans over tax policy and spending priorities.
Investors, however, have for months expected a deal would come down to the wire and markets were taking it in stride.
After a subdued day in Asia, where Japan's Nikkei as well as a number of other indexes had already shut for the year, limited year-end European trading left the MSCI all-world index on track to end the year up nearly 13 percent.
"It is still expected that a deal be reached in early January. That will probably be greeted positively by markets, but it looks like it will be a very short-term fix rather than one that addresses the longer-term issues," said Bank of Tokyo-Mitsubishi currency analyst Lee Hardman.
On Wall Street, the Dow Jones industrial average was up 7.45 points, or 0.06 percent, at 12,945.56. The Standard & Poor's 500 Index was up 4.53 points, or 0.32 percent, at 1,406.96. The Nasdaq Composite Index was up 17.63 points, or 0.60 percent, at 2,977.95.
The pan-European FTSEurofirst 300 has also 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.
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.
The benchmark 10-year U.S. Treasury note was down 10/32, with the yield at 1.74 percent, with some traders citing a possible deal on the fiscal cliff as weighing on bonds.
STILL RISKS AHEAD
That's not to say uncertainty will evaporate in 2013. For one thing, any deal to avert the U.S. fiscal cliff is expected to be a temporary fix that doesn't address a long-term plan to reduce the U.S. budget deficit, which has been above $1 trillion for four straight years.
Europe's debt crisis, meanwhile, has eased thanks to aggressive ECB efforts to protect the euro. Yields on Spanish and Italian sovereign bonds, a measure of the risk creditors attach to lending those governments money, spiked in the summer but have since fallen sharply.
Euro zone bond markets were closed for the day on Monday after a roller coaster year.
The euro was unchanged on Monday at $1.3210 but is 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, while deadlock is seen as dollar-positive.
"However the medium-term impact" of no U.S. budget deal is dollar negative, said Camilla Sutton, chief FX strategist at Scotia Capital in Toronto.
"The combination of aggressive Fed policy, the lack of a credible fiscal plan, a challenged political system and the impact of the fiscal drag should weigh on the dollar," she said.
Against the yen, the dollar rose as high as 86.64, its best showing since August 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 have been finding some 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 $1,662.70 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, shoring up this year's 5 percent gain.
Oil prices bucked the trend, however, slipping for a third consecutive session, with failure to reach a solution in U.S. budget talks seen likely to cause a serious slowdown in the global economy and a large drop in fuel consumption.
Brent crude was down 25 cents at $110.37 a barrel. It is up 2.8 percent and averaged more than $111.65 this year, its fourth successive year of annual rises and above the previous 2011 record of $110.91.
"Significant market moves are likely when the (U.S.) deal gets done - or if no deal is done before the year-end ... In any case, neither outcome is fully priced in," Jason Schenker, president of U.S. consultancy Prestige Economics.
(Editing by Chizu Nomiyama)