The Market Today

December’s First Day of Trading to Be Dominated by Republicans’ Efforts to Wrangle 50 Yeas for Tax Reform

by Craig Dismuke, Dudley Carter

Today’s Calendar – Tax Reform Will Be the Focus: There are a couple of key economic reports today and several Fedspeakers are slated to make remarks, but any and all of those are unlikely to have a significant impact on the markets. Instead, investors will be focused on developments surrounding tax reform. Republicans’ efforts to reform the U.S. tax code hit a snag late Thursday that pushed any votes on the plan to today at the earliest (more below). According to Senate Majority Leader McConnell, the first set of vote will begin at 10:00 a.m. CT (and could drag on all day). As to the economic data, today’s most important reports will be November’s ISM Manufacturing index scheduled for release at 9:00 a.m. CT and November’s auto sales results that will be announced throughout the day. The ISM index is projected to cool slightly for a second month after hitting its cycle-high in September. However, if the index is as expected, it would represent the strongest four-month average for the manufacturing ISM since 2011. Auto sales are also expected to have cooled from their September peak but if sales are in line with estimates, the 17.5MM unit pace would be the third best pace of the year. That would take that last three months to the strongest average sales pace since 2005 as individuals have ramped up buying to replace cars damaged in Hurricane’s Harvey and Irma. The only other major report on the schedule is the October construction spending report which should give some idea of how investment in structures fared in the first month of the fourth quarter. Investment in both business and residential structures were two weak spots in the 3Q GDP report.


Of the three scheduled Fedspeakers today, two of them – Kaplan (8:30 a.m. CT) and Harker (9:15 a.m. CT) – we’ve already heard make comments this week. James Bullard from St. Louis is scheduled to speak at 8:05. We have already heard from plenty of officials this week and, excluding comments from Kashkari, the messaging has seemed to support the market’s expectation for a December hike. We expect that will be reinforced again by Kaplan and Harker while Bullard will almost certainly side with his Minneapolis counterpart.


Overnight Activity – Tax Reform Giveth, and Tax Reform Taketh Away: The optimism around tax reform that sent U.S. stocks surging yesterday and Treasury yields climbing to their highest levels in some time (more below) checked up overnight. An announcement from Republicans late Thursday that a vote on the bill would be delayed until mid-morning today at the earliest took some of the wind out of the market’s sails. The delay came as several Senators showed some hesitations in voting for the bill as is. A couple want a larger child tax credit, paid for by tacking on a couple of percentage points to the 20% corporate rate. But the biggest sticking point seems to be with others who want phased-in tax increases of some sort to hedge against the risk of blowing up the deficit if the growth doesn’t pan out. Regardless of the reasons, the delay allowed uncertainty to creep back into the markets. European stocks are weaker after a mixed start in Asia and tech companies continue to bear the brunt of the blow. However, Friday’s tech losses haven’t been offset with gains in financials and other sectors as seen earlier this week given the uncertainty surrounding U.S. tax reform. Sovereign yields fell gradually throughout the session. U.K. yields, which led the way up this week, are leading the way down Friday with the 10-year note down 5.6 bps. The German 10-year yield fell 3.6 bps while the same maturity Treasury is down 1.4 bps to 2.40%. Sticking with the U.S., equity futures fell as the global backdrop soured and it appears tech will be the weak spot in the U.S. is well based on the underperformance of Nasdaq futures.


Yesterday’s Trading Activity – Stocks Climb and Yields Jump on Hopes Tax Reform is Nearer: It was an exciting day on Wall Street as markets shifted into full risk-on mode as the Senate seemed to move closer towards reforming the U.S. tax code. The big three equity indices all notched healthy gains with the Dow and S&P finishing at new record highs. The Dow was the top performer after adding 331 points, or 1.39%, to close above 24,000 for the first time ever. The index has added nearly 700 points over the last three sessions and that 2.9% gain is the best three-day run since immediately following the election. The S&P added a smaller but still impressive 0.82% gain while the Nasdaq trailed with a 0.73% increase. Stocks kicked into high gear just before 10:00 a.m. CT after headlines hit that Senator John McCain, a spoiler in the health care vote, would support the Senate’s tax plan. While the euphoria was clearly seen in equities’ performance, the Joint Committee on Taxation released its scoring of the Senate bill (more below) which served as a timely reminder of the bumpy road that still lies between here and the finish line. Treasury yields rose in response to the tax developments and stronger equity performance with certain maturities reached key levels Thursday. The 2-year yield climbed 2.0 bps to 1.782%, a new high for the cycle. The 5-year added 3.2 bps to close at 2.137%, in line with a March print that was the highest since April 2011. The 10-year yield rose 2.1 bps to 2.41% which was the highest level in just over a month. Despite all of the excitement elsewhere, the Dollar dipped as European currencies continued to strengthen on the progress related to the ongoing Brexit negotiations.


Scoring of Senate Tax Bill Shows Republicans Have a $1T Tax Problem: The Joint Committee on Taxation released its scoring of the Senate Republicans’ tax bill mid-afternoon on Thursday. That scoring estimated that economic activity would likely create additional revenues of around $458B over 10-years that would pay for less than a third of the total $1.4T net tax cut. Adjusting for increased interest expense of about $51B because of the larger deficit, the math showed the net effect of the plan would be a budget hole of around $1T ($1.4T tax cut – $458B new revenues + $51B additional interest expense) that Republicans will be forced to address. Other estimates from the report were that GDP would increase by 0.8% and employment would grow by 0.6%. Although the debating and compromising has already heated up, White House officials said they expected a vote to be pushed to Friday. If the tax bill passes the Senate, its likely to go to conference where differences between the House and Senate Plans will have to be hammered out.


Mester’s Okay with Continuing to Gradually Tighten Policy: Cleveland Fed President Loretta Mester said she agrees with current Fed Governor and Chair Nominee Jay Powell who said Wednesday that the case for a December rate hike is coming together. She added that with inflation expectations reasonably well anchored and the economy on firm footing heading into 2018, she believes it makes sense to continue raising rates at a gradual pace. While some estimates have the longer-run real neutral fed funds rate pegged at around 0.00%, Mester said her estimate is closer to 1.00% (nominal fed funds rate of 3.00%).

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