The Market Today
Yields Rise on Tax Reform Progress; Powell/Taylor Preference
by Craig Dismuke, Dudley Carter
Today’s Calendar – Powell/Taylor?; Budget Process; Existing Home Sales: The only economic report on the calendar today is the September Existing Home Sales report. However, the markets will be plenty preoccupied with guessing who the President may appoint as the next Fed Chair (very different market implications for Taylor vs Powell vs Warsh). It is most logical to deduce Powell will emerge as the candidate of choice. Moreover, the progress in Washington on a 2018 budget will be a center of attention. Nonetheless, existing home sales are expected to drop 0.9% in September as the hurricanes continue to disrupt activity. If other home-sale reports are any indication, the existing report may fall even further. Existing sales are already down 6.1% from their peak in March. Fed Chair Yellen will speak at 6:30 p.m. CT tonight with Q&A. However, Yellen is the Fed equivalent of a lame duck at this point leaving traders/investors to dial out and tune into the Yankees-Astros game at 7:00 p.m CT.
Overnight Activity – A Push Forward for U.S. Tax Reform, Potentially Hawkish Fed Chair Candidate Send Yields Higher Friday: Another step forward on U.S. tax reform gave investors their latest reason to extend global equities’ year-to-date gains. Stocks around the world are almost exclusively higher Friday after the U.S. Senate adopted a budget resolution late Thursday evening in a razor-thin 51-49 vote, the next step in the tax reform process. Republicans will now attempt to reconcile the Senate’s version with the House resolution passed two weeks ago in order to leverage the filibuster-proof reconciliation process to push through the tax changes (more below). U.S. equity futures spiked higher on the news but have since given back roughly half of those gains. Contracts on the S&P are up roughly 0.25% in early trading. Treasury yields also jumped pushing the entire term structure two years and out higher by at least three basis points. The 2-year yield added 3.4 bps to 1.56%, the highest yield since October 2008. The 5-year yield is up 4.7 bp and trading at 2.00% for the first time since March. Adding to the upward pressure for yields was a report that added John Taylor’s name to the short list of White House favorites to be the next Fed Chair. Several hours earlier, markets responded dovishly to a report that had Jerome Powell as the President’s current top choice (more below).
Yesterday’s Trading Activity – Buy-the-Dip Conditioning Drives Equities Rebound, Powell Report Drops Yields and the Dollar: A depressing start for U.S. equities gave way to an equally impressive recovery. After dropping more than 100 points (-0.43%) in the first hour of trading, the Dow reversed and never looked back. The steady recovery pushed the index positive just before the close. The five-point gain (0.02%) was enough to notch another record high. The S&P trended similarly to a less than one-point gain (0.03%) and a record high of its own. While momentum had clearly turned positive early, there was a notable nudge higher in the final few minutes. At 2:58 p.m. CT, two minutes before the stock market closed, reports hit the wires that President Trump was leaning towards current Fed Governor Jerome Powell to be the next Fed Chair. Powell is seen as the most dovish candidate excluding the incumbent. While stocks jumped on the news, Treasury yields and the Dollar dropped. The 2-year yield was the most volatile considering the potential implications of a Chair Powell on monetary policy decisions. The 2-year yield ended near its daily low, down 3.3 bps at 1.53%. The 10-year yield closed down 2.9 bps at 2.32% but off its session low reached earlier as stocks hit their daily bottom. The dovish market response to the Powell report also impacted fed funds futures where the curve flattened quickly. Thursday’s moves were a reminder of the potential volatility that could occur once the final decision of who will be the next Fed Chair is made.
House and Senate Pass First Steps in Long Tax Plan Process: After the house and Senate both passed 2018 budgets, the next step for Congress to overhaul the tax code is getting both chambers to agree to the same budget framework. The Senate version provides for a revenue-reducing tax cut which would increase the deficit by $1.5 trillion over the next 10 years, in contrast to the House version which allows for a deficit-neutral tax cut. Leaders are now attempting to bridge those two budgets without having to go to a conference committee. Whatever changes are made to the FY2018 budget would need to then be approved by both the House and the Senate. Next, the budget would go to the House Ways and Means Committee (24R-16D) which would then piece together all of the details of the tax plan, including things like the income cutoffs for the three proposed brackets, what the highest personal bracket would be, what exemptions and deductions would remain, etc… After approval at the committee level, the plan would go to the full House for a vote. Next, the Senate Finance Committee would lay out the details of its tax plan. That plan must make it out of the committee (14R-12D) and to the full Senate for a vote. Presuming both the House and Senate tax plans are approved by their respective chambers, the plans would likely go to a House-Senate conference to iron out any differences. Then the House and Senate would both vote again before the overhaul package would be sent to the President’s desk. All of the full-chamber votes would require simple majority votes.