Late last night the U.S. House of Representatives passed a Senate bill that will prevent the U.S. economy from going over the fiscal cliff. Congress agreed to a mix of tax increases on high income earners (avoiding a tax increase for all Americans), various deduction caps including an overall limit on the dollar amount of itemized deductions, a tax increase on large estates, a permanent AMT fix, an increase in dividend and capital gains taxes, and other measures. Financial markets are cheering the deal, with stocks up and Treasury bonds selling off in a classic “risk-on” trade. Our initial take on the deal focuses on three points: 1. Payroll taxes will rise by 2% for every working American 2. No agreement was made on the debt ceiling increase and 3. The automatic spending cuts known as sequestration are delayed by 2 months to early March. These three points are important as they will likely have a negative impact on economic growth in the new year. The 2% payroll tax increase equates to a $95B reduction in discretionary income for consumers. The debt ceiling breech will occur in early March if Congress fails to increase the U.S. debt limit. This, along with the delayed sequestration sets the stage for another round of contentious negotiations in Washington. During the last debt ceiling debate in 2011, Congressional inaction and debate led to a volatile financial environment. We have no reason to believe this time will be any different as House republicans have stated any debt ceiling increase will have to come with major spending reductions. The President has said that spending cuts will not be a part of any debt ceiling negotiations. We are expecting these issues to hamper the economy in the first quarter and full year, setting the stage for a continued low growth, low inflationary environment. This, coupled with the Federal Reserve’s massive quantitative easing program may mean a continued low rate environment, setting the stage for good performance from bonds.