Fiscal Cliff Dive

The US fiscal cliff compromise reduces the fiscal drag in 2013 by about 0.1%, this is due to a smaller tax increase and more generous unemployment benefit extension. The Senate voted 89-8 whilst the House of Representatives voted 257-167. Top tax rate increased from 35% to 39.6% for individual income over $400k and couples over $450k, with tax deductions reducing over $250k. Unemployment insurance was extended by one year at a cost of $30bn. Estate taxes will increase from 35% to 40% for estates over $5m

The burden of higher taxes will fall hardest on the top 1 percent and particularly on the top 0.1% of taxpayers. Those making more than $2.7 million will pay an average of $444k more in 2013, or 26% of the additional burden, according to the Tax Policy Centre. Households with income between $500,000 and $1 million will pay an average of $15k more.

The U.S. hit the debt limit Dec. 31 and the Treasury Department began employing so-called extraordinary measures to finance about $200 billion in deficits in 2013. A debt limit increase will be needed as early as mid-February, according to the Congressional Budget Office, and the automatic spending cuts will start taking effect March 1.

There was a raft of Manufacturing PMI data from Europe, with Euro wide printing 46.1 (exp 46.3, prev 46.3), German 46.0 (exp 46.3, prev 46.3), Italian 46.7 (exp 45.3, prev 45.1), French 44.6 (exp 44.6, prev 46) and Danish 57.0 (prev 56.6). EU YoY Harmonised CPI rose to 2.1% (exp 1.9%, prev 1.9%).

Germany sold €4.15bn two-year notes with a positive yield for the first time since October, with an average yield of 0.01%. That contrast with- 0.01% at a previous auction on Dec 5^th, receiving €6.24bn of bids, it expected to sell €5bn. The two-year yield rose four basis points to 0.02%. German regional CPI’s also upticked, with Saxony YoY 2.2% (prev 2.0%), Brandenburg YoY 1.9% (prev 1.5%), North Rhine Westphalia YoY 2.1% (prev 1.9%), Baden Wuerttemberg YoY 1.9% (prev 1.5%) and Bavaria YoY 2.2% (prev 2.1%).

Markit Economics and the Chartered Institute of Purchasing and Supply said in London today that U.K. manufacturing for December surprisingly grew at the fastest pace in 15 months, to 51.4 (exp 49.1) from a revised 49.2 for November, as domestic demand strengthened. One caveat Markit noted was that companies remained cautious and reluctant to hire. Markit economist Rob Dobson said, “There are increasing signs of firms starting to move out of this cost-cutting mode, though it is clear that the outlook remains far from certain…..Business confidence among producers therefore remains fragile and could easily be derailed.” Manufacturing employment fell for an eighth month, input costs increased the most in nine months and output price rose the most in eight months.

The market took the fiscal cliff news very well with a strong risk on tone to trading. Equities across the world ended the day higher, peripheral bonds rallied against the aggressive sell off in US, UK and German sovereign debt, leading to significant spread tightening by London close. E.g. Germany/Spain 2y -50bps, Germany/Portugal 10y -57bps, Germany/Greece 10y -31bps, even Germany/Italy 5y -34bps.