T-note yields surge after House tax bill passage with inflation expectations reaching 7-3/4 month high
Tax bill headed for passage after Senate’s revision
Congressional attention turns to CR
U.S. existing home sales expected to remain strong
BOJ expected to leave policy unchanged
Weekly EIA inventories
T-note yields surge after House tax bill passage with inflation expectations reaching 7-3/4 month high — The 10-year T-note yield on Tuesday moved sharply higher to post a 1-3/4 month high and close +5.8 bp at 2.452%. The 10-year T-note yield stopped just short of challenging the 9-month high of 2.476% posted in late October.
The main factor behind Tuesday’s sharp rise in T-note yields was the House passage of the tax bill, which boosted expectations for Fed tightening in 2018 and also boosted inflation expectations. The 10-year breakeven inflation expectations rate on Tuesday rose by +2.2 bp to post a new 7-3/4 month high of 1.93%. Meanwhile, the market boosted expectations for Fed tightening in 2018 by 2 bp to a total of 49 bp from 47 bp on Monday. There was also heavy selling in T-note futures as the Dec 10-year T-note future showed a technical breakdown by falling to a new 9-1/4 month low on the nearest-futures chart.
Meanwhile, the S&P 500 index on Tuesday fell by -0.32% on (1) the sharp sell-off in T-note prices, and (2) some buy-the-rumor sell-the-fact action after the House passed the tax bill. The dollar index on Tuesday closed -0.28% despite the rise in U.S. interest rate differentials.
Tax bill headed for passage after Senate’s revision — The House on Tuesday easily approved the tax reform bill by a margin of 227-203. However, the Senate then had to vote on a slightly different version since some measures did not meet reconciliation rules. Assuming the Senate met expectations by approving the bill on Tuesday night, the House today will have to approve the revised Senate version, thus completing Congressional approval. After Congressional approval, the bill will be signed by President Trump and implementation will begin in just two weeks on Jan 1, 2018.
Once the tax reform bill is approved, the stock market will turn towards assessing the extent to which after-tax earnings will actually rise for particular companies in 2018 due to the complex tax bill. The markets are also waiting to see how much overseas corporate cash is repatriated and is distributed to investors via stock buybacks and higher dividends.
Congressional attention turns to CR — After a brief period of euphoria on the ability to use reconciliation to approve the tax bill, Republican leaders will return to bipartisan reality where Senate Democrats have a filibuster veto over legislation. Republicans and Democrats are still at loggerheads over the continuing resolution that must be passed by Friday night at midnight to prevent a U.S. government shutdown. The gulf between Republicans and Democrats on a spending bill for the remainder of the fiscal year and the various tag-along measures suggests that Congressional leaders may be forced to simply roll over the current CR into January and deal with the difficult issues then. In any case, a government shutdown before this week’s Christmas holiday seems unlikely.
U.S. existing home sales expected to remain strong — The market consensus is for today’s Nov existing home sales report to show a +0.9% increase to 5.53 million, adding to October’s +2.0% increase to 5.48 million. U.S. existing home sales remain in strong shape at only -2.9% below the 10-3/4 year high of 5.70 million units posted in March 2017.
U.S. home sales remain strong due to buoyant U.S. consumers and the continued low level of mortgage rates. However, home sales are being curbed to some extent by the tight availability of homes on the market and by the sharp run-up in home prices that has been seen in recent years. There were only 3.9 months worth of homes on the market in October, which is much tighter than the long-term average of 7.0 months. Meanwhile, the median price of an existing home of $247,000 in October was just moderately below the record high of $263,300 posted in June 2017.
BOJ expected to leave policy unchanged — The market consensus is that the Bank of Japan at its 2-day meeting on Wed-Thu will leave its policy unchanged. BOJ Governor Kuroda in his press conference is expected to reiterate the BOJ’s recent themes and is not expected to hint at any near-term policy changes. The BOJ is expected to leave its deposit rate at -0.1% and its 10-year JGB yield target near 0%. The BOJ is expected to reiterate the nominal 80 trillion yen size of its annual QE program. However, the reality is that the BOJ has purchased only about 60 trillion yen of securities over the past year as it varies the amount of its QE purchases to pursue its goal of keeping the 10-year JGB yield near 0%.
There is little reason for the BOJ to shift its policy gears at this point since the central bank is still waiting for inflation to climb towards its 2% target. Japan’s core CPI has been at 0% for the last three months, far below the BOJ’s 2% target. Japan’s headline CPI popped up to +0.7% y/y in Aug-Sep but then fell back to +0.2% in October. The BOJ in 2018 may take some of its first moves towards tightening if the economy remains strong and inflation starts to move higher. The BOJ is likely to take its first moves toward tightening by raising its deposit rate to zero and its 10-year JGB yield target by 10-20 bp.
Weekly EIA inventories — The market consensus for today’s weekly EIA report is for a -3.0 million bbl drop in U.S. crude oil inventories, a +2.4 million bbl rise in gasoline inventories, an unchanged level of distillates, and a +0.2 point increase in the refinery utilization rate to 93.6%. U.S. oil inventories have fallen sharply in recent weeks and are now +12.0% above the 5-year seasonal average, which is substantially tighter than the +24% level seen just three months ago. Meanwhile, product inventories are near normal levels. Gasoline inventories are +3.0% above the 5-year seasonal average, while distillate inventories ate -3.6% below average.