Hours before fiscal cliff is breached

Photo: The Canadian Press. All rights reserved.

Speaker of the House John Boehner, R-Ohio, walks to a closed-door GOP caucus as Congress meets to negotiate a legislative path to avoid the so-called "fiscal cliff" of automatic tax increases and deep spending cuts that could kick in Jan. 1., at the Capitol in Washington, Sunday, Dec. 30, 2012. (AP Photo/J. Scott Applewhite)

Markets appeared Monday to be taking in stride the prospect that U.S. politicians will fail to agree a budget deal in time to avoid automatic tax increases and spending cuts that many economists think could tilt the world's largest economy back into recession.

With just hours to go before the U.S. falls off the so-called "fiscal cliff," Republicans and Democrats remained divided over tax and spend, raising the prospect that markets will start 2013 without a clear idea of America's budget policy. The main sticking point appears to be what level of taxes are imposed on higher incomes.

Discussions in the Senate broke off Sunday night without an agreement. The Senators will return to their offices Monday to try and hammer out a deal before the deadline.

"With the gulf between both parties still wide and the desire to protect their supporters' key interests so ingrained, it is difficult to see how both sides can compromise enough to agree a deal at this point," said Rebecca O'Keeffe, head of investment at Interactive Investor.

However, it's not the first time that budget discussions in the U.S. have gone down to the wire, and investors remain confident that some sort of deal will be reached, if not Monday then in the coming days or weeks. As a result, they think that the potential damage wrought by higher taxes and spending cuts will be limited.

In addition, a backup proposal that would address only a few issues is expected to be presented by Senate Majority Leader Harry Reid, a Democrat, if a bipartisan deal is not reached.

The prospect of counter-measures to offset the "fiscal cliff" impact helps explain why markets were fairly calm in Europe and Asia, and Wall Street was poised to open higher.