Today the markets are buzzing on a tentative fiscal package that could extend the Bush tax cuts, emergency unemployment benefits, and even reduce social security taxes that come directly out of workers’ pockets. On the surface, this appears to be a fresh fiscal injection of liquidity that should act to bolster economic growth and has a chance to keep animal spirits focused on the bullish case for risk assets over a cyclical horizon.
The bad news is that the proposed package will cost almost $1 trillion, and it certainly flies in the face of a true concerted effort to reduce our country’s debt load. It wasn’t too long ago something called the deficit commission essentially concluded our nation is on an unsustainable fiscal path. Throughout 2010 we have also been witnessing a return of the global bond vigilantes. One of the lessons of this year might be that too much debt will ultimately force bond market adjustments, and those adjustments can ripple quickly through financial markets.
The proposed tax package is not a done deal, and Democrats are already voicing some major displeasure with the proposal. Assuming it gets passed without material changes, it seems destined to be a catalyst. But, will it be a positive catalyst for rising risk asset prices, or a negative one that causes a return of the U.S. bond vigilantes? That distinction could be the difference between another big leg up, or marginal new highs that succumb to a riot in the bond market.
