Today’s Alabama Senator special election could affect the chances for the tax bill
FOMC rate hike chances pegged at 100%
U.S core PPI expected to remain at 5-3/4 year high
30-year T-bond auction to yield near 2.77%
Today’s Alabama Senator special election could affect the chances for the tax bill — The outcome of today’s special election for Alabama Senator could affect the tax reform bill if Congress cannot get the tax bill passed by next Friday.
The new Alabama Senator is not expected to be sworn in until early January. However, if the certification process occurs much more quickly than expected, then the new Alabama Senator could be sworn in as early as Dec 23. That reinforces next Friday’s (Dec 22) effective deadline for a tax vote for avoiding the impact of the next Alabama Senator as well as meeting the Republicans’ self-imposed year-end deadline.
If Congress cannot get the tax bill approved by next Friday, then whomever becomes the new Alabama Senator will come into play in January, if the tax bill is still in progress. If Democrat Doug Jones wins the election, then the Republicans’ majority in the Senate will be cut to 51-49 from 52-48, which is one fewer Republican Senator that Senate Majority Leader Mitch McConnell can afford to lose for supporting the tax bill.
Even if Republican Roy Moore wins the election, Senate Majority Leader McConnell could still have new problems with the tax bill if Mr. Moore opposes the tax bill or demands big changes.
Republican leaders are still aiming to get Congress to approve the tax bill by next Friday (Dec 22) before recessing for the Christmas holiday. Tomorrow will be a big day for the tax bill with the House-Senate tax conference committee holding its only public hearing on the tax bill and with President Trump scheduled to deliver a speech on closing arguments for the tax bill.
The latest betting odds are 67% for a corporate tax cut by year-end and 89% for a cut by March 31, 2018, according to PredictIt.org.
FOMC rate hike chances pegged at 100% — The market is discounting the chances for a +25 bp rate hike at the 2-day FOMC meeting that begins today at 100%, according to the federal funds futures market. The January 2018 federal funds futures contract yesterday closed at 98.605 (1.395%), which means that the federal funds rate is expected to average 1.395% during January, up by more than +25 bp from the current mid-point funds rate target of 1.125%.
A rate hike at this week’s FOMC meeting would make good on the Fed-dot forecasts for three rate hikes this year. However, the new mid-point funds rate target of 1.375% would still be below current inflation levels, meaning that the funds rate will still be at a negative inflation-adjusted level. With the strong U.S. economy, stable overseas conditions, and the tight U.S. labor market, there is no reason at present for a negative inflation-adjusted funds rate. The only reason for the low funds rate is that the Fed can only afford to raise interest rates slowly in order to avoid shocking the economy into a new slump.
The Fed in any case believes that it will be raising the funds rate another three times in 2018, which would take the funds rate up to 2.10%, according to the Fed-dot forecasts. The Fed is then expecting another 2-1/2 rate hikes in 2019 to 2.70%, which is close to the Fed’s current view of the long-term federal funds rate equilibrium level of 2.75%. That 2.75% funds rate would be 75 bp above the Fed’s 2.0% inflation target, implying a modestly positive inflation-adjusted funds rate of 0.75% if expected inflation by then is running near +2.0%.
U.S core PPI expected to remain at 5-3/4 year high — The market consensus for today’s Nov final-demand PPI report is for a slight uptick to +2.9% y/y from Oct’s +2.8%. However, the consensus is for the Nov core PPI to be unchanged from Oct’s level of +2.4% y/y.
The PPI is showing considerable strength with both the Oct PPI of +2.8% and the core PPI of +2.4% at 5-3/4 year highs. However, the CPI and PCE deflator are both substantially lower. The CPI in October was at +2.0% y/y and the core CPI was at +1.8% y/y. The
PCE deflator, which is the Fed’s preferred inflation measure, was at only +1.6% y/y in October and the core PCE deflator was at +1.4% y/y.
While the PCE deflator remains at low levels that is causing some consternation at the Fed, inflation expectations remain stable and are just below the Fed’s +2.0% inflation target. The 10-year breakeven inflation expectations rate, which measures the difference between the nominal and TIPS 10-year T-note yields, is currently at 1.90%, towards the upper end of the range of 1.83%-1.91% seen since October. That indicates that the market is looking past the weak PCE deflator statistics and is expecting inflation to be near the Fed’s +2.0% target over the next 10 years.
30-year T-bond auction to yield near 2.77% — The Treasury today will sell $12 billion of 30-year T-bonds, concluding this week’s $56 billion coupon package. Today’s 30-year T-bond auction will be the first reopening of last month’s 2-3/4% 30-year bond of Nov 2047.
The benchmark 30-year T-bond was trading at 2.77% in late yesterday afternoon. That translates to an inflation-adjusted yield of 0.82% against the current 30-year inflation expectations rate of 1.95%.
The 12-auction averages for the 30-year T-bond are as follows: 2.30 bid cover ratio, $5 million in non-competitive bids to mostly retail investors, 5.6 bp tail to the median yield, 29.9 bp tail to the low yield, 42% taken at the high yield, and 63.1% taken by indirect bidders.