Morning Report - Happy New Year

Vital Statistics:

	Last	Change	Percent
S&P Futures	1445.5	25.4	1.79%
Eurostoxx Index	2705.2	69.3	2.63%
Oil (WTI)	93.3	1.5	1.61%
LIBOR	0.305	-0.001	-0.33%
US Dollar Index (DXY)	79.45	-0.282	-0.35%
10 Year Govt Bond Yield	1.84%	0.09%
RPX Composite Real Estate Index	191.8	-0.5

Markets are higher this morning after the government reached a compromise on the fiscal cliff.  It turned out the bond market (which was refusing to rally in spite of the setbacks along the way) was correct in its forecast.  When stocks and bonds are telling you different things, listen to the bond market -  it is usually right.  The 10-year is at the top of its recent 1.55 - 1.85 trading range.  MBS are down.

The House passed the Senate compromise on the fiscal cliff late last night, taking income tax hikes for most people off the table (although taxes are going up for everyone with a job).  Here are the main effects:

• Tax rates will increase to the Clinton level rates for incomes over 450k
• Limits on itemized deductions kick in at incomes > 300k
• Capital Gains and Dividends rise to 20% for incomes over that threshold
• Estate tax set at 40%, with a $5 million threshold that will be indexed to inflation
• The sequester will be delayed for 2 months
• the AMT will be permanently patched and indexed for inflation.
• Extended unemployment benefits continue

The debt ceiling was not addressed in this deal.  The end deal is more or less a tax hike with no spending cuts. It looks like they extended the tax relief for principal mods / short sales as well.  So, unless you make over $300k, you are fine, right?  Nope.  77% of all households will see their taxes increase because the payroll tax holiday expired.

On to the debt ceiling, where Obama has already said he won't accept spending cuts without further tax increases. That will be a contentious debate, since Republicans already walked the plank with their base and voted for tax hikes without Democrats giving up a thing.  Given that Republicans have voted for tax hikes already, the "Republicans are unreasonable" arguments will lose some of their sting.  They will be emboldened to push for more spending cuts, which the White House will refuse. While the WH had the benefit of circumstance in the fiscal cliff negotiations, where the default outcome was a big tax hike, now Republicans have the benefit of circumstance where the default outcome is where spending gets cut (as the sequester was merely delayed, not eliminated).  Punch line, things will get ugly again in Washington, so look to fade this rally.

Bob Schiller is not convinced we are off to the races in the housing recovery.  Basically, he believes housing has hit "fair value" and isn't going anywhere for a while. He may be correct, and that house price inflation will go back to its old relationship with incomes.