David Axelrod, the new WH Senior Adviser (what does that title mean?) leaked an e-mail yesterday [which was subsequently denied] that a “compromise” had been reached on what to do with taxes for the next few years. All of the Bush tax cuts will be extended for another 24 months. AMT will also get “patched” up for a few years. So the great public debate on this critical issue actually never happened. The outcome was not really in doubt. That said, this is a pretty big deal. Consider this graph from the CBO:
The graph shows the impact of extending and patching versus a base line estimate of the deficit. If we extend/patch the deficit goes up by $147b in 2011 and by $208b in 2012. So the compromise that was not discussed or debated will cost us $355b over two years. Poof!
As a result of this non-legislating the deficit will go up by more than half of all of Ben Bernanke’s $600b QE. Yes, he will be buying more than Treasury will be selling for the next seven months. But right after that Timmy G. will have at least another trillion and a half of wood to chop over the following eighteen months.
The old adage of “Don’t fight the Fed” is probably wise as you look at their massive buy program. But after a few months we are going to get numb to the constant POMO operations. At around that same time people will be looking at the Fed’s dwindling buying power and the wave of supply around the corner. The news on taxes today just makes the problem worse. Would you lend those prolific spenders your reserves? At a negative return?
Bernanke’s announcement eight days ago knocked the long bond off its feet. The Fed committed less buying power to the 17-30 year maturities than was anticipated. But the 30 year has been trading like a wet sack of cement ever since QE-2 was announced. That price action is not all about some overestimates on the Fed’s intentions. Those bad bets were washed out after the first 24 hours. At this point the bond is pricing in a market sentiment that says, “If the Fed isn’t buying it, don’t own it.” I can’t think of a worse market response to the cauldron of trouble that Ben has cooked up.
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