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Tuesday Look Ahead: Tax Compromise is Gift to Markets as Traders Await Santa Rally

The proposed extension of Bush era tax cuts is another gift to markets and makes a year-end Santa rally even more likely.

President Barack Obama
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President Barack Obama

President Obama Monday said he would support a tentative compromise to keep in place all Bush tax cuts for two years, as well as extend unemployment benefits for 13 months. The White House also added a reduction in the Social Security tax for workers to 4.2 percent from 6.2 percent for a one-year period.

Traders and analysts, for weeks, have been predicting an extension of all of the tax cuts, including those that keep capital gains and dividend taxes at a maximum 15 percent.

However, if those tax cuts and taxes for the wealthy were not to be extended, as proposed by some Democrats, traders had expected to see stock market selling. They also had been expecting a relief rally once a deal was announced. The deal still needs approval of Congressional Democrats.

James Paulsen, chief investment strategist at Wells Capital Management, said he thinks any relief rally will be limited. "It's all in the market. It was as expected. Anything less would have been bad."

"I think, more than anything, the certainty and tax predictability will help business job creation and the economy," Paulsen said.

U.S. stock futures turned slightly positive Monday evening, after President Obama announced the tax deal at about 6:30 p.m. New York time. The Dow Monday had ended down 19 at 11,362, and the Nasdaq was up 3 at 2594. The S&P 500 fell 1 to 1223.

Euro-dollar See Saw

Markets Tuesday face another dose of headline risk from the euro zone. The Irish Parliament is expected to consider the government's new austere budget Tuesday morning New York time.

Late Monday, European finance ministers said they did not plan, as of now, to expand the size of their bailout fund, as rumored in the market. Euro zone finance ministers hold a second day of meetings Tuesday.

Adoption of the Irish government's budget is a requirement for Ireland's bailout package. "It will be a shock if it fails," said Boris Schlossberg of GFT Forex. "The market is pretty much expecting it to go through. If it fails, it could be a serious political crisis in the Euro zone." The euro Monday lost 0.7 percent against the dollar, to a level of 1.3314.

Schlossberg said the euro and dollar have been reacting to news in a seesaw fashion. "It's the sovereign crisis in Europe versus the perpetual QE (Fed quantitative easing). That's the seesaw that keeps going with the euro," he said.

Commodities broke trend Monday and some moved higher, even as the dollar gained. Precious metals jumped on comments from Fed Chairman Ben Bernanke on "60 Minutes" that the recovery could take awhile and that there could be further Fed easing, beyond what has been announced. Gold climbed to a record $1,427.01 an ounce late in the session, and silver reached $30 an ounce for the first time since 1980.

Crude oil edged close to the psychological level of $90 per barrel, finishing Monday at $89.38, up 0.2 percent. Orange juice futures, meanwhile, surged 4.8 percent as a cold snap headed to Florida.

Cowen and Co's head stock trader John O'Donoghue said he expects the stock market to consolidate gains this week, but it should pick up steam and rally at the end of December into the New Year.

O'Donoghue, who spoke just after 4 p.m., said the stock leadership should stay the same into year end. "The old favorites are just doing better. Google was up 1 percent, and Apple was up almost 1 percent, and you'll probably have that kind of movement until the end of the year," he said. O'Donoghue also mentioned Amazon , another gainer Monday.

These market favorites are also the stocks that traders had said they expected to see investors unload if the capital gains tax were to be raised next year, since they have built up such large gains. Those type of stocks and dividend plays, like the DVY dividend ETF, could get some support from the tax announcement.

Traders are also watching the Treasury's three auctions this week. On Tuesday, the Treasury issues $32 billion in 3-year notes at 1 p.m. Traders are particularly interested in the 10-year Wednesday and the 30-year bond auction Thursday. The 10-year yield fell to 2.939 percent Monday.

Much of the talk in markets Monday focused on Europe, the fallout from Friday's weak jobs number and the Sunday night appearance by Bernanke on "60 Minutes."

"We're heading into that quiet time period. The fire works for this week really start on Wednesday when we have to set up for the 10-year and 30-year auctions and then depending on how that outcome goes, people will be highly anticipating that FOMC meeting, given the "60 Minutes" interview last night," said Nomura Americas head Treasury strategist George Goncalves. "Bernanke was vehemently defending what he was doing. The question in my mind is will that translate into more explicit language.. we have QE, (quantitative easing) but Bernanke says they're going to examine the efficacy of how its going."

- Follow me on Twitter @pattidomm.

Questions? Comments? Email us at marketinsider@cnbc.com

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

  • CNBC Senior Commodities Correspondent and Personal Finance Correspondent

  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.