The Market Today
Tax Reform, Debt Ceiling, and Spending Authority Take the Stage
by Craig Dismuke, Dudley Carter
Today’s Calendar – New Home Sales Expected to Hold in July: Mortgage applications for the week ending August 18 fell 0.5% on a 1.5% drop in purchase apps, a 0.3% increase in refi apps, and unchanged 30-year mortgage rates (4.12%). Looking at the bigger picture, the overall trend for purchase apps has been weaker since mid-June and refi apps remain very low. At 8:45 a.m. CT, the Markit PMI reports on manufacturing and service sector activity are expected to show a slight pullback in manufacturing offset by a slight increase in the service sector. The biggest report of the day will be the 9:00 a.m. release of July’s new home sales data. Economists expected the sale of newly constructed homes to be unchanged for the month, holding at a relatively good level for this cycle. Dallas Fed Bank President Kaplan is scheduled to speak to an oil group in Midland, TX at noon but his opinions are already well known – therefore unlikely to move markets. More likely to move markets are the Washington soundbites on 1) tax reform, 2) the debt ceiling, and 3) a possible government shutdown.
Possible Consensus Growing on the How-To for Tax Reform: An early-morning Politico report moved tax reform to the forefront of Tuesday’s trading session. The report, citing multiple informed sources, indicated there may be a consensus building around several options for reforming the U.S. tax code. After the scrapping of the BAT proposal several weeks ago imperiled the hopes for significant reforms, the “Big 6” – the group of heavy-hitting White House aides and congressmen heading the tax reform charge – is searching for how to pay for the desired tax cuts. The report from Politico indicated a potential agreement among the group’s members on several possible options: (1) capping the mortgage interest deduction, (2) doing away with the deduction for state and local taxes, and (3) replacing the business interest deduction with a phased-in full expensing of capital expenditures. The report indicated a realistic corporate rate would likely fall between 22% and 25%, north of President Trump’s desired 15% corporate rate. The likelihood of a one-time repatriation holiday was also mentioned. Moreover, Senate Minority Leader Schumer reiterated on Monday two conditions to gain the support of Democrats on any tax reform. He said, “We believe strongly that not one penny go to the top 1 percent and that any tax reform must be deficit neutral. … When Republicans figure out what they want to do, we’d be happy to work with them if they can agree on these broadly supported principles.” Tax reform is expected to be the focus this fall and any twists and turns have the potential to create market volatility.
Overnight Activity – Global Risk-Off Tone Strengthening ahead of U.S. Session: Wednesday’s overnight trading has reflected no signs of the positive energy that boosted U.S stocks and Treasury yields on Tuesday. A firmness in Asian equities faded into more dispirited trading in Europe. After gaining 0.83% Tuesday, the Stoxx Europe is 0.36% lower with most sectors in negative territory. The more cautious tone has also created a bid for the Yen and sent German yields lower while lifting those in Italy, Spain, and Portugal – all conventional risk-off moves. The Dollar dropped sharply against the Yen late Tuesday after President Trump proposed allowing a government shutdown if funding for a border wall is excluded from any proposed spending bill. The Euro rallied against the Dollar following generally stronger-than-expected PMIs in France and Germany. The Dollar’s losses continued its notably volatile week of trading. The risk-off tone has accelerated over the last couple of hours. U.S. equity futures are weaker and near session lows, indicating a partial reversal of yesterday’s gains at the open. Treasury yields are near session lows with the 2-year note 0.8 bps lower (1.31%) and the 10-year note down 2.8 bps (2.19%).
Yesterday’s Trading Activity – Tax Talk Boosts Stocks and Treasury Yields: Pre-market open trends proved prescient in predicting how U.S. trading would unfold. Stocks jumped early as futures had predicted and climbed almost ceaselessly throughout the day. All three major U.S. indices closed near session highs. The Dow rallied 196 points, or 0.90%, to notch its best day since late-April. The S&P added 24 points, or 0.99%, 0.01% shy of its best day over the same period. The Nasdaq outperformed, by gaining 1.4% in its best session since the end of June. Tech companies were top performers but the strength was contagious. Six of the 11 S&P sectors gained more than 1% while the rate-sensitive real estate sector faltered as Treasury yields climbed. Treasurys had been under pressure overnight but yields climbed further in U.S. trading. The 2-year yield added 2.0 bps to 1.32% while the 10-year yield finished up 3.1 bps at 2.21%. The Dollar rallied and completely erased Monday’s sharp loss. With a quiet economic calendar, and in the absence of anything significant on the geopolitical front, the optimism was attributed to a Politico report describing positive developments on the tax-reform front (more above).