The Market Today
Biggest Hurdles Cleared for Tax Reform
by Craig Dismuke, Dudley Carter
Expected Impact of Tax Reform: With tax reform finally looking to be a done deal, we have revised our outlook for 2018 just fractionally (we previously built in close to a 90% chance of something getting done leading to small revisions now). The economy is likely to expand near 2.8% in 2018, the fastest pace of annual growth of this recovery/expansion. This acceleration should be built on improvement in consumer spending (more disposable income) and an increase in business investment (albeit a slower process than the impact on consumption). Inflation is projected to be firmer in 2018 giving more credibility to the expectation that the 10-year Treasury yield is likely to move up near 2.75%. Additionally, weaker inflation was the primary cause for projecting only two Fed rate hikes in 2018. Three hikes now becomes more credible presuming inflation firms as expected. However, we continue to believe inflation and interest rates will both remain relatively range-bound versus previous cycles. There are significant implications for some fixed income portfolio managers as addressed in a Strategic Insight published by Vining Sparks’ Strategic Solutions group yesterday.
Today’s Calendar – Tax Reform: Mortgage applications for the week ending December 15 fell 4.9% as purchase apps fell 5.5% and refi apps dropped 3.2%. On a 4w/4w moving average basis, purchase apps have jumped recently after pulling back approximately 10% from late June through early November. Refinance apps have slowed to a crawl once again as mortgage rates have remained mostly steady, but higher than they were pre-election. The 30-year mortgage rate quoted by the MBA report is currently at 4.16%, down 30 basis points from the post-election high of 4.46% back in March. However, the same rate was 3.62% just prior to the 2016 elections.
At 9:00 a.m. CT, the November Existing Home Sales report is expected to show a 0.9% increase in sales MoM. However, the focus will remain on tax reform with a House re-vote expected this morning. The Senate always appeared to be the biggest hurdle and House passage seems to be a technicality. Then the bill will move to the President’s desk for his signature. This is all expected to occur in the next 24 to 48 hours.
Overnight Activity – Senate Passes Tax Bill, Kicks it Back to the House for Clean Up: The Senate passed its tax bill around midnight last night, clearing what should be the last major hurdle for Congress before it can send a tax bill to the President for his signature (the House will have to vote on the bill again to clean up a handful of items). But the Senate’s passage failed to spark any new upside momentum for foreign equities. Asian stocks rose 0.1% on average while European stocks have ticked lower by a similar amount. However, here at home the mood has been a little merrier. U.S. equity futures are comfortably in positive territory signaling a rebound at the open and recovery of at least some of yesterday’s decline. The muted reaction by equities to major tax code changes becoming a near reality isn’t surprising considering the big gains made when tax reform seemed possible. Sovereign yields, on the other hand, seem to have taken more of a show-me approach. After holding stubbornly steady during most of the process, longer sovereign yields have made notable moves this week as the voting has taken place. European yields are up again overnight with Germany’s 10-year adding more than 2 bps to 0.40%, the highest since mid-November. The German 10-year bund has risen 9 bps in two days, the biggest two-day move since July. Treasury yields are also climbing again and the long-end continues to lead. The 30-year bond is up 3.5 bps while the 10-year yield has risen 2.0 bps. One thing that did not change overnight, and hasn’t throughout most of the tax-reform process, is the Dollar’s apathy towards it all.
Yesterday’s Trading Activity – Stocks Slide and Treasury Yields Spike as U.S. House Votes Yes on Tax Reform: Shares of U.S. tech companies tumbled Tuesday, as evidenced by the Nasdaq’s underperformance, but was part of broader selling that created daily losses for the big three indices. The equity weakness evolved despite the House passing the tax bill and sending it along to the Senate for debate and a vote (after markets closed, the Senate kicked the bill back to the house for another vote because some of the provisions violated Senate budged rules). For the day, the Dow dropped less than 0.1% as the S&P slipped 0.2% and the Nasdaq dropped 0.4%. While the Nasdaq lost the most, the tech sector was just the fourth worst performer within the S&P behind telecoms, utilities, and real estate related companies. Those other sectors, sometimes considered bond proxies, experienced bigger declines at least in part because of the big moves in the Treasury markets. The long-end of the curve whipped the most, with the 30-year yield rising 7.9 bps to 2.82%. Added to Monday’s 5.3 bps rise, the Tuesday move made it the biggest two-day yield increase of the year for the Long Bond. The 10-year yield rose another 7.0 bps, taking its two-day total increase to 11.1 bps, the largest since September (fourth largest of 2017). There were a confluence of factors that likely played a part in the upshift in yields. While stocks have run higher in anticipation of tax reform, longer Treasury yields have been almost immovable; actual passage may have finally loosened the lid a touch. Also applying pressure were higher yields in Europe. Yields had already made most of their climb before the afternoon House vote with some traders pointing to speculation about the nature of future supply in some European countries and some hawkish comments from a well-known hawkish ECB official.