The Market Today

German Coalition Talks Breakdown; Progress Continues on Tax Plan with Big Hurdles Aheads


by Craig Dismuke, Dudley Carter

Today’s Economic Calendar – Leading Economic Indicators Index Likely to Show Strong Results:  The only economic release today is the Leading Economic Indicator index which is expected to show a 0.8% MoM increase, which would be the best rate of gain in three years.  Recent data shows jobless claims down MoM, stronger manufacturing activity, good housing permits data, higher stock prices, and stronger consumer confidence.  All of these should help boost the index.  The markets, however, will be more focused on any news out of Washington on taxes (more below).

 

Overnight Activity – German Political Uncertainty Briefly Creates Market Jitters: Global equities are off to a mixed start with a similar indecisiveness seen across the sovereign debt markets. Uneven results during the Asian session preceded a more cohesive but unimpressive move higher for European equities. The early-week global economic calendar offered no significant catalyst for traders which left the focus on European politics. The small gains for European equities followed a bit of weakness at the open. The early-session nerves followed Sunday reports that German Chancellor Merkel’s attempts to form a new government had failed (more below). The news initially sent the Euro tumbling during Asian trading but the currency staged an almost-complete recovery when European markets opened. There were no other broad signs of a flight to quality with gold and the Yen modestly changes. Sovereign yields in developed countries did move lower, but only modestly so. As U.S. traders have arrived to work, the lower yields on the Treasury curve have faded. The 2-year yield is up 0.4 bps to 1.72% after falling more than 1 bp overnight. After a notable decline last week, the 10-year yield recovered from a more-than 2 bp overnight drop and is 1.1 bps higher at 2.35%.

 

ICYMI – November 17, Weekly Market Recap: Between the 2-year and 10-year portions of the curve, Treasurys experienced the biggest week of flattening (-12 bps) in almost three years. The 2-year yield remained locked in with fed funds futures which continue to project the next rate hike in December. There was little response by the short-end of the curve to steady U.S. economic data, another step towards tax reform, and some atypical volatility in the equity markets. Small business optimism, industrial production, retail sales, homebuilder confidence, and housing starts and building permits all improved. Producer price inflation perked up and the YoY Core CPI rate broke a 5-five month run at 1.7% and ticked higher (to 1.8%) for the first time since January. The full House passed their tax plan while the Senate advanced its plan out of committee. Global equities faltered in the first couple of days of trading and the S&P declined 0.55% on Wednesday. The Wednesday drop broke a streak of 50 consecutive trading sessions without a 0.5% decline, the longest streak since 1965. That quiet streak is reflective of how calm 2017 has been for U.S. equities on average. For the full year, the average daily percentage change on an absolute value basis is just 0.3%. That is the second least volatile result reaching all the way back to 1928. The tech sector led a Thursday rebound which helped the Nasdaq turn positive for the week; the Dow and S&P both finished negative. Despite the equity rebound, longer yields finished lower with the 10-year yield closing at 2.34%. Click here to see the full recap.

 

Coalition Talks Breakdown Increasing Risks to Merkel’s Chancellorship:  German Chancellor Merkel’s talks to form a coalition government broke down over the weekend, calling into question her ability to remain in her role as Chancellor.  The three parties negotiating the coalition government reportedly could not reach consensus on a policy for refugees (a common theme over the last year-plus), tax policy, and energy policy.  As a result, one of the two minority parties, SPD, pulled out of the talks.  According to a UBS analysis of the situation, there are four scenarios going forward: 1) Merkel’s CDU try to bring the FDPs back to the negotiating table, 2) Merkel’s CDU party attempts to form a grand coalition with the SPD party (the SPD party received the second-largest vote total and have insisted that they do not want to be part of a coalition), 3) a minority government could be formed (the first one in-war Germany and unlikely to achieve anything legislatively), and 4) new elections could be called.  As for the market impact, this certainly creates some uncertainty – not so much for German economic stability but for Eurozone integration negotiations and Brexit talks.

 

White House Okay with Dropping Senate Plan’s Repeal of Individual Mandate:  One of the biggest challenges facing the reconciliation of the two tax plans working their ways through Congress right now will be the Senate version’s call to repeal the ACA’s individual mandate.  The move allowed the Senate’s plan to save $338 billion (10-year window), according to the CBO, in part by 1) eliminating the health insurance subsidies for lower income households ($185 billion savings) and 2) reductions in Medicare expenditures ($179 billion savings).  However, there are conflicting estimates, and narratives, about the impact.  First, according to IRS tax data, almost 80% of the individual mandate tax is paid by households making less than $50,000 – obviously this would be good news for them.  Second, the impact of reducing the pool of covered persons would increase premiums for all insured, all else being equal.  CBO estimates that premiums would increase 10 percent annually.  One potential fix for this would be to eliminate the coverage requirements for all insurance plans so that stripped down versions could be sold (in which case we would be getting really close to the old model of health insurance). Third, fewer people would likely be covered, although many of those may be self-selecting and preferred.  According to CBO’s projections, 16 million fewer people would have coverage by 2025.  Fourth, and paramount for those who want to look through the rhetoric likely to dominate the news headlines for the next few weeks, CBO’s estimates are inexact and likely to be wrong.  According to the CBO’s most recent report, “The preliminary results of analysis … indicates that the estimated effects [of repealing the mandate] on the budget and health insurance coverage would probably be smaller than the numbers reported in this document.”  Most interesting this morning, Budget Director Mulvaney said over the weekend that the White House is fine with repealing the mandate or not.  He said, “I don’t think anybody doubts where the White House is on repealing and replacing Obamacare: We absolutely want to do it. If we can repeal part of Obamacare as part of a tax bill and have a tax bill that is still a good tax bill that can pass, that’s great … If it becomes an impediment to getting the best tax bill we can, then we’re OK with taking it out.”

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