The Market Today

Yellen Acknowledges Inflation Paradigm May Be Inaccurate; Tax Reform Unveiled

by Craig Dismuke, Dudley Carter

Today’s Calendar – Tax Reform Unveiled; Durable Goods Orders Rise in August; Fedspeak:  The Big Six, a group of influential Republican leaders working on tax reform, will release a new joint statement today laying out the details of their most recent reform proposal.  The President is expected to speak on the proposal at 2:00 p.m. CT.  According to Politico, the plan is expected to call for “A 20 percent top corporate rate; 25 percent for ‘certain’ pass-through businesses; three individual rates of 12, 25 and 35 percent with instructions for committees to add a fourth higher bracket if they choose; repatriation at a one-time lower rate and then a territorial system… Five years of immediate expensing; some limits on corporate interest deductions; a doubled standard deduction and expanded child tax credit; no corporate or individual AMT; no inheritance tax; elimination of most individual deductions but not mortgage interest or charitable deductions; elimination of most credits on the business side but not for research and development or low-income housing.”  Given this past week’s most recent flop by republicans to pass healthcare legislation, it is logical to question the likelihood of any tax reform passing.  However, as discussed in the Overnight Trading section, the market is responding with optimism.


As for the economic data, August’s Durable Goods Orders beat expectations across the board.  Total orders for items that last longer than three years rose 1.7% versus expectations for a 1.0% increase.  The headline jump was driven by a 45% increase in nondefense aircraft leaving orders ex. transportation up just 0.2%.  However, the July figure was revised up from +0.6% to +0.8%.  As for capital goods orders excluding defense and aircraft, order growth tripled expectations rising 0.9% MoM. Likewise, the shipment of those capital goods items rose 0.7% versus expectations of a 0.1% rise.  Both measures indicate a stronger rate of business investment than expected which should be a boost to 3Q GDP.  Mortgage applications for the week ending September 22 fell 0.5% on a 2.8% increase in purchase apps and a 3.5% drop in refi apps.  However, the bigger picture (4-week moving average) shows refi apps picking up some pace as mortgage rates have fallen but purchase apps pulling back more recently.  August’s Pending Home Sales report will be released at 9:00 a.m. CT and is likely to show another drag from Harvey.  Kashkari, Bullard, Brainard, and Rosengren are all on the tape today.


Overnight Activity – Yields Rise on Yellen’s Outlook, Optimism on Tax Plan Release:  Sovereign yields are under steepening pressure overnight and the Dollar has extended its weekly gain to 1.4%. Gold continued to weaken and U.S. equity futures strengthened with most major global indices. Yesterday’s remarks from Fed Chair Yellen still pointing to a December hike have kept pressure on the short-end of the curve as evidenced by the modest increase in the Fed Funds Futures curve. The futures contract settling in December 2018 was trading at 1.585%, pricing in at least one full hike and a roughly 90% chance of another by the end of next year. The implied rate in the December 2018 contract has risen in 12 of the last 14 sessions and is the most hawkish pricing since July 10. The 2-year Treasury yield is up 2.0 bps to 1.47% marking its highest yield since October 2008. The 3-year yield is 3.0 bps higher at 1.60%. However, traders are pointing to today’s release of the GOP’s tax reform plan as the primary catalyst for the higher longer-yields and notable curve steepening. The 5-year yield is up 5.1 bps to 1.91% and the 10-year yield is 6.2 bps higher at 2.30%; both are the highest since July (when the Fed’s inflation debate began in earnest). As highlighted in a morning note from Vining Sparks Director of Trading, Mark Evans, yields have shot higher over the last two and a half weeks: 2-year Treasury +20bps, 5-year Treasury +27bps, 10-year Treasury +25bps. Those recent shifts have helped push the Dollar higher and gold lower, both to levels last seen on August 22.


Yellen Acknowledges Inflation Paradigm May Be Inaccurate:  In Janet Yellen’s speech yesterday at the NABE conference, she acknowledged that the Fed may be missing something on the inflation puzzle, conceding that it was possible the economy could possibly sustain a higher rate of output with lower unemployment.  If so, she said that scenario could require a more accommodative stance for monetary policy.  She balanced that openness with saying that based on their current understanding, it was appropriate to continue adjusting monetary policy at a measured pace.  She cited the belief that inflation would rebound in the medium term and the risk that the labor market could overheat.  However, her admission that their paradigm could be wrong reflected less confidence in that view.  Generally, this is the same position Chair Yellen has had recently.  The uncertainty over the inflation picture is unlikely to lead to a quick change in policy direction (unlikely to affect the odds of a December hike).  Given that her tenure as Fed Chair ends in February, her evolving position may become irrelevant if she is not reappointed.  However, if she is, it is very likely to become relevant.


Atlanta’s Bostic Believes Yellen Is “Super Smart”:  Atlanta Fed Bank President Bostic (2018 voter), in some of his first public comments on monetary policy, said yesterday that he isn’t too concerned about asset bubbles now, sees positive signs that inflation is moving to 2%, believes a December rate hike appears appropriate, and thinks Chair Yellen is “super smart.”


New Home Sales Fall With or Without Harvey:  New Home Sales for the month of August fell 3.4% as the data were once again affected by Hurricane Harvey.  Sales in the South region fell 4.7% which, as was the case with the existing home sales data, was partially the result of delayed activity from the late-August hurricane.  Unfortunately, Hurricane Harvey is likely to affect activity in the South again in September while Hurricane Irma is likely to exacerbate the weakness.  While the weather is wreaking havoc on some of the economic data, the weak new home sales data is not all to blame on the storms.  Sales in the Northeast fell 2.6%, sales in the West fell 2.7%, and sales in the Midwest were flat.  Even excluding sales in the South, new home sales in the rest of the country are now down 16% since March’s peak.  On a QoQ tracking basis, new home sales are now down 5.5% in 3Q, down 4.9% when excluding sales in the South.


The July S&P CoreLogic Home Price index showed a better-than-expected gain in the 20-city index, rising 0.35% MoM and bringing the YoY rate of price gains up from 5.65% to 5.81%.


Consumer Confidence Remains Strong Despite September Pullback:  September’s Conference Board report on consumer confidence showed a small pullback after a negative revision to the August index (revised down from 122.9 to 120.4).  However, the overall report remains quite strong with confidence at 119.8 and consumer expectations for income and spending remaining good.  The percentage of respondents expecting to buy a major appliance over the next six months rose 3.5% while those expecting to go on vacation rose 7.2%.  Those expecting to buy cars fell just 0.8% and those expecting to buy a home fell 0.4%.  Respondents expecting to receive an increase in income rose 0.6 points while those expecting a decrease fell 0.3 points – for a net differential of +0.9 points.  However, consumers who perceived jobs as being plentiful fell 1.8 points, although the index still portends a further decline in the unemployment rate.  Overall, despite September’s mild pullback, confidence remains very strong and consistent with a meaningful increase in personal consumption.


Spreads Hold Firm Despite Higher Treasury Yields Providing Buying Opportunity (Vining Sparks Weekly Sector Updates, James Plunkett):  The slope of the Treasury curve inside of two years increased over 15bp during the two most recent weeks while the balance of the curve moved in an almost parallel fashion. … With the exception of municipal debt, investment grade products underwent yield movements consistent enough with Treasuries to cause very little in the way of spread changes. While current market conditions may not leave a lot of room for anything spectacular in terms of spread tightening, the fact that these spreads remained more or less intact during the Treasury yield increases of the last two weeks suggests … a buying opportunity in spread products…”

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