Taxes took center stage this week, as President Obama announced a tax compromise that would extend the Bush tax cuts for all, while also providing fairly favorable treatment of capital gains, dividends and the estate tax. In exchange, unemployment benefits would be extended for an additional year, while a surprise reduction in the payroll tax could potentially add up to 0.7% to GDP next year.

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Taxes took center stage this week, as President Obama announced a tax compromise that would extend the Bush tax cuts for all, while also providing fairly favorable treatment of capital gains, dividends and the estate tax. In exchange, unemployment benefits would be extended for an additional year, while a surprise reduction in the payroll tax could potentially add up to 0.7% to GDP next year. In an interesting reversal, the president is trying to sell the proposal to his party, with the liberal wing of the House in full revolt. We ultimately feel that the major parts of the tax proposal will be passed before year-end, although there will likely be Washington drama associated with it.

Bond vigilantes have taken the tax proposals as affirmation of their deficit concerns, and have summarily sold off Treasury securities, particularly on the long end. The curve has steepened as a result and yields on the 10-year have risen by their largest amount in a year. The 10-year presently stands at 3.31%, a far cry from the 2.38% level of early October. Prices of risk assets have also weakened, but credit fundamentals remain strong, and the sell-off appears more duration inspired than anything else.

This will be our last weekly commentary for 2010, so want to wish all our readers a Happy Holiday season and the best for a Joyous New Year. Our last monthly fixed income call is scheduled for this coming Wednesday, December 15. Please join us as we provide a 2010 wrap up and an outlook into 2011.