Medicare

Shooting arrows at kids who are five years old today is nothing to celebrate, even if the arrows won't hit for another decade or two.

As reported previously, when Bloomberg broke the news two days ago, it now appears that the official appointment of Jack Lew as the new SecTres will take place tomorrow. From Bloomberg: "President Obama will announce tomorrow that White House Chief of Staff Jack Lew is his pick for Treasury secretary, person familiar with the matter tells Bloomberg’s Han Nichols." In other words - goodbye Timmah: best of luck writing your new book, which in the tradition of every ex-public servant who departs the government where they kept their mouths firmly shut, we assume will be all about bashing Tim Geithner.

If corporate earnings have topped out, what will push the stock market higher? The usual answer is "central bank intervention," but history suggests that in the long run, the market eventually correlates to corporate earnings. Earnings up, market up; earnings down, market down.

Bloomberg is out after hours with news that was expected by many, but which was yet to be formalized, until now: namely that following today's flurry of contntious nomination by Obama, the latest and greatest is about to be unveiled - Jack Lew, Obama's current chief of staff, is likely days away from being announced as Tim Geithner's replacement as the new Treasury Secretary of the United States. In other words, Jack will be the point person whom the people who truly run the Treasury, the Treasury Borrowing Advisory Committee, chaired by JPM's Matt Zames (who just happens to also now run the notorious JPM Chief Investment Office which uses excess deposits to gamble - yes, you really can't make this up) and Goldman's Ashok Varadhan, global head of dollar-rate products and FX trading for North America (recently buying a $16 million pad at 15 CPW) will demand action from.

• Secret and Lies of the Bailout (Rolling Stone)
• Banks Win 4-Year Delay as Basel Liquidity Rule Loosened (BBG)
• Hedge Funds Squeezed With Shorts Beating S&P 500 (BBG)
• Bankruptcy regime for nations urged (FT)
• Is the Fed Doing Enough—or Too Much—to Aid Recovery (WSJ)
• Cracks widen in US debt ceiling debate (FT)
• McConnell Takes Taxes Off the Table in Debt Limit Negotiations (BBG)
• Abe Seen Spending 12 Trillion Yen to Boost Japan’s Economy (BBG)
• Monti, Berlusconi Spar on Taxes in Weekend Media Barrage (BBG)
• Cameron Sets New Priorities for U.K. Coalition (BBG)
• Defiant Assad Rules Out Talks With Rebels (WSJ)
• Korea Seen Resisting Rate Cut as Won Threatens Exports (BBG)

Why must the debt grow every year? To keep the debt-servitude paradigm going. To increase economic activity in a country operating in this type of system, you need to increase the level of credit and thus debt grows in tandem. This is self serving: if debt is the “fuel” to increase economic activity, interest payments will become larger and larger, until eventually it reaches a point where debt can no longer be increased. This point is known as the Minsky moment–when there is no net benefit to extra debt. So there we have it, in our “creditopia” world, if debt does not expand, the economy cannot grow and jobs cannot be created. In order to increase debt, foreigners have to continually finance the ever growing debt by purchasing government bonds and selling consumer products to the US. In turn, the US must increase the level of consumption, decrease savings, and eliminate the threat of any nation posing a risk to the US dollar hegemony. Is this a symbiotic or a parasitic relationship? Is is certainly a relationship that cannot grow forever. It poses an economic risk for ALL nations due to the interconnectedness of the global economy.

We are living in the United States of Delusion. The delusion has four key sources. The irony is that clinging to delusion rather than face the necessity of deep cuts in borrow-and-squander budgets will lead to the involuntary reset of the entire system, depriving every vested interest of their share of the swag. Is delusion a sustainable state? No. Thus we can confidently predict that causality, factuality and karma will eventually sweep aside delusion and all those who cling to it.

• After the worst post-Christmas market performance since 1937, we had the largest surge to kick off any year in recorded history
• The myth is that we are now seeing the clouds part to the extent that cash will be put to work. Not so fast It is very likely that much of the market advance has been short-covering and some abatement in selling activity
• As equities now retest the cycle highs, it would be folly to believe that we will not experience recurring setbacks and heightened volatility along the way
• The reality is that the tough choices and the tough bargaining have been left to the next Congress and are about to be sworn in
• The myth is that the economy escaped a bullet here. The reality is that even with the proverbial "cliff" having been avoided, the impact of the legislation is going to extract at least a 11/2 percentage point bite out of GDP growth

The Cliff is dead; long live the Cliff.  Yesterday’s impressive market rally was a great way to kick off the New Year, but (as ConvergEx's Nicholas Colas notes) we do have 251 trading days to go before we can lock in those gains and dance a celebratory jig.  The market’s psychological pendulum swings between extremes of “Macro” and “micro” focus, and we shouldn’t take it for granted that the stock market’s positive take on the Fiscal Cliff negotiations portend a better economy, a stronger financial picture for the U.S., or any of the actual nuts-and-bolts which hold together the framework of corporate earnings and cash flows.  Colas' prime concern is that the increase in Social Security tax withholding by 2 percentage points – back to its pre-2011 12.4% - will take a chunk out of the spending power for tens of millions of households.  In the abstract, the amounts involved are not huge – perhaps 50 basis points of GDP.  But everything counts when GDP growth remains stubbornly subpar.

I left yesterday for the bobbling heads - to the artists of verbiage that weave arguments of their own accomplishments much as the artists of Three Card Monty hide the truth behind their shells. Yesterday we had a nice rally in the equity markets. No surprise; the sigh of relief was palpable that Congress did something, anything to address our fall over the cliff. I would not get too excited however. We raised taxes, we penalized those succeeding and we did it in a meaningful manner. We did not cut the national debt as sung by the chorus across the airwaves. In fact, according to the Congressional Budget Office we decreased revenues by $3.6 trillion over ten years. We did not protect the middle class, but because of the expiration of the payroll tax decrease, Federal taxes will rise for 77% of all working Americans. Thus we rewarded non-working Americans at the expense of those with jobs. The game was the continuation of postponement and avoidance and reckless governance of the nation.

Having passed the 'easy-do-nothing' bill that created a 5% uplift in US equities, D.C. have left the most difficult set of issues for last: entitlement reform, which Republicans have said they will insist upon in return for raising the debt limit, and tax reform, which the President has said he will insist on in return for entitlement reform. The upshot is that reaching an agreement on the next debt limit increase could be at least as difficult as the last increase in August 2011. As Goldman notes, the next debate on the debt limit will be the fifth "showdown" on fiscal policy in the last two years. Adding further angst, in the summer of 2011 politicians had started the debate some three months prior to the real deadline. This time it appears that nothing serious will happen until the 11th hour as usual, meaning far more last minute volatility. However, one new twist to this now familiar routine may come from the rating agencies, which look likely to be more active in 2013 than they have been since 2011.

US Vice President Biden and Senate Minority leader McConnell brokered an agreement that was approved by the Senate that seems to avoid the full fiscal cliff.  It now is before the House of Representatives.  

While the Jan 1 deadline is passed, the more significant one, we had argued was Jan 3, when a new Congress is sworn in.  A failure by the 112th Congress to finalize the legislation would mean that process would have to begin anew with the 113th Congress. 

After what is likely to be intense though short debate, the House of Representatives can either approve the same exact bill the Senate approved, which be the quickest resolution.  It can seek to amend the bill, in which case it must return to the Senate for their approval.  The process could be cumbersome and require reconciliation and would risk the Jan 3 deadline.  Alternatively, a majority of the House could fail to ratify the Senate bill, in which case, it will be up the next Congress to claw back from the other side of the cliff.

Scenarios:

1. A close vote before 6PM – Asian markets open up, catching up to the Monday S&P move; S&P futures probably have priced in most of the benefit of the fiscal cliff resolution. EUR CAD, and AUD have a bit of catching up to do with the S&P, but there should be little drama
2. A rancorous debate that extends into the night – again the key will be whether the votes are there, however, reluctantly, but if it looks as if support is waning we will see sharp moves in markets. With brinkmanship the new normal, the sell-off will be partial on the view that a last minute rabbit will be pulled from a hat.
3. Amendments or rejection – markets will sell off sharply.  If it turns out that the House can’t vote ‘yes’ on an acceptable, yet inelegant fix, the confidence that has emerged in 11th hour fixes will dissipate and tail risk scenarios will shift into baseline outcomes. This would be USDJPY negative,  but risk-correlated currencies now price in 80-90% probably of a successful fix in our view, so the downside pressures will be large.

Time is running out. The cliff negotiations have devolved into two unpalatable options: (1) extend just the middle income tax cuts and extended unemployment benefits and allow about two-thirds of the cliff to happen, or (2) go over the cliff in the entirety. In BofAML's view, given the short time frame and legislative hurdles, the latter appears much more likely. Stock market vigilantes have replaced bond vigilantes as the potential good, bad, and ugly scenarios are devoured flashing red headline by flashing red headline. They, like us, believe that going over the cliff is not a benign “slope” as some suggest. Rather, it accelerates the already-building damage to the economy and markets. The latest evidence is the plunge in consumer confidence. Indeed, this could mark the beginning of the rotation in the uncertainty shock from businesses to consumers. Going over the cliff has many secondary, largely ignored, negative impacts, including tax changes that could damage the housing recovery, as well as negatively impact education and alternative energy, among many others.

Just in case the stakes in the final episode of the 2012 season of the "Fiscal Cliff" soap opera, and a 30 second advertising block was not selling for a record amount, here comes the Pentagon with a warning that it may fire almost 1 million civillians their services will be required but unpaid if there is no Cliff deal. From the WSJ: "Mandatory federal spending cuts designed to be prohibitively drastic will become a reality on Wednesday if negotiators remain unable to reach an agreement to avert the reductions. Illustrating the gravity of the cuts, the Pentagon plans to notify 800,000 civilian employees that they could be forced to take several weeks of unpaid leave in 2013 if a deal isn't struck, and other agencies are likely to follow suit. The cuts, which members of both parties have referred to as a "meat ax," are the product of a hastily designed 2011 law that required $110 billion in annual spending reductions over nine years to reduce the deficit. Their severity, representing close to 10% of annually appropriated spending, was intended to force Democrats and Republicans to come together on a broader package of deficit-reduction measures, which would replace the cuts. That effort failed, raising the prospect of the cuts' taking place."