Congress Passes Tax Deal, Markets Rejoice

Welcome back. We hope you had a restful and relaxing break. For the politicians of the 112th Congress it was however, a working holiday over the past few days in their quest to avoid the US toppling over the so-called “fiscal cliff.” How successful have they been?

We have been critical of European politicians through the past 2 years, of coming to Eurogroup meetings and leaving with nothing but an armful of Eurofudge and little else, so it we would be in remiss if US politicians didn’t come in for the same treatment.

The bill approved in the early hours of New Year’s Day by the Senate and by the House of Representatives extends the Congress’s ability to continue negotiations. The agreement however, revolves solely around tax increases, with not a single spending cut being agreed upon. It looked in the early hours of last night that we would see a Republican attempt to add spending cuts to the bill and send it back to the Senate. This was given up on, but the fact that the majority of Republican representatives voted against the bill shows their unhappiness towards it.

The markets are happy however that while the cliff has not strictly been avoided, Congress has had the good sense to strap a pillow to its backside before taking the plunge. The next fight has already begun and will focus on the spending cuts and also the debt ceiling.

While the US has, in technical terms, already hit its $16.4trn borrowing limit, the Treasury announced over the Christmas break that they would apply “extraordinary measures” to find enough money to keep going for 2 months. We all remember the fight that took place in the Autumn of 2011 over that and the fears that the US could default on its debt wrecked risky assets’ chances. While the markets are reacting positively so far to the news from Washington, future protractions will act as a weight around the neck.

As well as being the first trading day of the year it is PMI day in global economics. Both South Korea’s and Taiwan’s manufacturing PMIs have moved back into expansionary territory highlighting the area of the world’s economy that is likely to see the most growth in 2013. The wave of readings will sweep across Europe and the UK in the coming hours where the expectation is for further contraction for the manufacturing industries there.

Price action is still being determined by returning liquidity with GBPUSD hitting a 15 month high in the aftermath of the US vote. EUR/USD saw a similar rally leaving GBP/EUR flat as the proverbial. With the immediate tail risk of the fiscal cliff removed the focus will not shift decidedly towards individual data points.