Senate Blocks Middle Class Tax Cut Extension, As Treasury Will Soon Need To Issue Yet More Trillions In Bonds To Fund Revenue Shortfall (Which Fed Will Monetize)

Tyler Durden
Zero Hedge
Dec 5, 2010

The recent passage of the middle class tax cut extension by Congress was roundly refuted by the Senate today as republicans and even some democrats voted against the proposal. This was expected, and means the bluff will come down to the wire, with some form of compromise required in the next week, involving an unemployment insurance-for-tax cut extension quid pro quo. It better come quick though: as Zero Hedge has been saying for the past 4 months, the biggest overhang on the market currently is the threat that the capital gains extension does not pass forcing a sell off as those in profitable position rush to lock in profits at lower rates (which is priced in to assume it will happen). This was finally made all too clear in a recent Strategas report that gained prominent recognition a few days ago. However, instead of this issue requiring resolution by the end of the month, the D-Day is actually December 15, at which point numerous option expiration/rolling decisions are made, impacting asset decisions on the underlying securities.  As to the tax cut extension, it is now more than obvious that Obama will be forced to soon renege on some of his key campaign promises, thereby making his presidential bid in 2012 even more of a non-starter, but more importantly, requiring the Treasury to fund even more government revenue shortfalls through bond printing, thereby making a new QE round (this time focusing on the 30 Year) all but guaranteed.

More  from Reuters:

The two Democratic plans to renew low tax rates for individual income up to $200,000 and up to $1 million both failed in procedural votes, as Republicans argued that low tax rates for the wealthiest should also be extended.

No Republicans backed the Democratic proposals, and a few Democrats voted against them.

President Barack Obama expressed disappointment on Saturday and said negotiators needed to “redouble” their efforts in the next few days to reach an agreement on the tax cuts. He said doing so “will require some compromise.”

The rare Saturday votes were expected to fail, but Democrats wanted to show that they didn’t support an extension of the lower rates for higher-income individuals.

“It’s not that we want to punish wealthy people,” said Democratic Senator Charles Schumer, who had proposed extending the tax rates for those earning up to $1 million. “But they are doing fine and they are not going to spend the money and stimulate the economy.”

Ultimately, today’s vote was nothing but more theater:

Senate Republican leader Mitch McConnell after the vote said he was “relatively confident” that bipartisan talks would lead to an across-the-board renewal of the tax cuts and that the only unknown was the length of the extension.

Republicans also said the votes were a waste of time.

“The American people don’t want a political dog and pony show,” Republican Senator Charles Grassley said. “The bottom line is this: Stop the tax hikes.”

And here is how the quid pro quo will look, making it inevitable that not only will the Treasury have to issue an addition several hundred billion in Bonds to fill the revenue deficiency, but that the Fed will have to step up its QE to further monetize the balance, an issue we will get some additional color on tomorrow when the Inkjet Chancellor speaks on 60 Minutes:

Obama’s top economic advisers are in talks with key lawmakers on a potential deal that could renew all the lower rates, including those for the wealthiest, for one to three years, according to congressional aides.

In return, Democrats are demanding a one-year renewal of jobless benefits for hundreds of thousands of Americans. The benefits began to expire this week when lawmakers failed to agree on an extension.

In other words, the government continues to rely on the expectation that borrowing trillions from the future to fund shortfalls now will continue without a glitch. However, if rates continue rising as they have in the recent week, this assumption will be very much challenged as this next Reuters report discusses in detail.

The slope of the Treasury yield curve steepened in the week just ended, a week of volatile trading, observed Ward McCarthy, chief financial economist and managing director in the fixed-income division of Jefferies & Co. in New York.

“With supply on the horizon, a distinct lack of market liquidity and real money accounts still looking to lighten positions into year-end, rates appear to be headed higher in the weeks immediately ahead,” he said.

The Treasury will sell $29 billion in three-month bills and $28 billion in six-month bills on Monday. It will sell $32 billion in three-year notes on Tuesday and $21 billion and $13 billion in re-opened 10- and 30-year securities, on Wednesday and Thursday, respectively.

At the same time the shadow cast by a weaker-than-forecast November U.S. employment report should make any upward move in rates a modest one, they said.

Benchmark U.S. 10-year yields hovered above 3 percent on Friday and seemed destined to do so in the weeks to come.

Bottom line: the Fed better hope it can rein in the 30 Year: for now it is starting to lose control, which is why we expect that when Bernanke announce the specifics of the next next QE iteration, purchases in the 30 Year sector will be prominelty featured.