- Weekly market focus
- Fed expectations turn more dovish
- SPX holds near a 5-week low while 10-year yield slides
- Health care defeat suggests potentially quicker but scaled-back corporate tax plan
- 2-year T-note auction to yield near 1.27%
Weekly market focus — The markets this week will be hoping to get some details from the White House or Congressional Republican leaders about the timing and content of a tax reform plan, which has now become their main legislative priority. There will be ten appearances by Fed officials this week including comments by Fed Chair Yellen on Tuesday at a community reinvestment conference. The markets will be listening for any new comments on the Fed’s balance sheet after Fed officials last week stepped up their comments on that key topic. The UK on Wednesday will officially declare Brexit.
This week’s key U.S. economic reports include (1) Thursday’s Q4 GDP report (expected +2.0% vs last +1.9%), which will include Q4 corporate profits, and (2) Friday’s Feb personal income and spending report (expected +0.4% and +0.2%, respectively) and Feb PCE deflator (expected +2.1% headline and +1.7% core).
The Treasury this week will sell $101 billion of T-notes starting today. There are only six of the S&P 500 companies that will release earnings this week including Red Hat today; Darden Restaurants, McCormick, and Carnival on Tuesday; and Paychex and Perrigo on Wednesday.
Fed expectations turn more dovish — The federal funds futures curve last week turned more dovish by -3 bp for Dec-2017, -6 bp for Dec-2018, and -7 bp for Dec-2019. The market is now expecting another 78 bp of Fed tightening by the end of 2018, which is -16 bp less than the peak of 94 bp seen just three weeks ago. The market is not fully discounting a 100% chance of the Fed’s next rate hike until the Sep 19-20 meeting. The market is discounting only about a 60% chance of a second rate hike by December.
SPX holds near a 5-week low while 10-year yield slides — The S&P 500 index last Friday closed just slightly lower by -0.08% despite the news before the close that the House canceled its health care vote. The stock market must now adjust to the revised prospects for the Republican agenda, which has been a key driver of the post-election rally, along with the stronger U.S. economy and expectations for strong +11% growth in SPX earnings growth in 2017.
The 10-year T-note yield last week fell sharply from the mid-March 3-month high of 2.63% to close the week at 2.41% due to reduced concern about Fed tightening as the Republican health care agenda ran into trouble. T-note yields also fell due to the decline in the 10-year breakeven inflation expectations rate to a 3-month low of 1.95% on Wednesday, although that rate rebounded a bit higher to 1.98% by Friday. Inflation expectations fell last week as the May WTI crude oil contract on Wednesday fell to a 4-month low of $47.01 and closed the week down -2.72% at $47.95.
Health care defeat suggests potentially quicker but scaled-back corporate tax plan — The good news for the stock market from last Friday’s failure of the AHCA health care bill was that tax reform jumped to the front of the line and no longer has to wait for health care to get passed by Congress. The stock market is mainly interested in a cut in the corporate tax rate, since that cut would drop straight to the stock market’s bottom line through higher after-tax earnings for shareholders. Treasury Secretary Mnuchin on Friday said the goal is to get tax reform done before the August recess although he admitted that deadline might slip.
However, the bad news for the markets from the AHCA failure was that the Republicans may be forced to scale back their corporate tax reform plans. Speaker Ryan was relying on the AHCA to repeal about $1 trillion in Obamacare taxes over 10 years, which could have been used to boost the size of the tax reform package.
The failure of the AHCA also means that Republicans may decide to trim the size of the corporate tax program to make it easier to pass. Republicans may decide that they now need a relatively quick win and can’t afford to get bogged down in a big fight over controversial proposals like the border adjustment tax system (BAT) or phasing out the ability for businesses to expense interest on debt. Those proposals have already received heavy fire from affected industries and some Republican Senators.
The stock market has so far taken the failure of the AHCA largely in stride, if only because it accelerated the consideration of corporate tax reform. The question now is what exact corporate tax reform package the White House and Speaker Ryan will propose and how long it will take to get it enacted. A member of the House Ways and Means committee, Rep. Kenny Marchant (R-TX), last Friday said that he thinks it will be some weeks before a tax reform bill is released. However, starting this week, there should be plenty of discussion in Washington about tax reform as a pivot away from health care.
2-year T-note auction to yield near 1.27% — The Treasury today will sell $26 billion of 2-year T-notes, kicking off this week’s sale of $101 billion in T-notes. Today’s 2-year T-note issue was trading at 1.27% in when-issued trading late last Friday afternoon, which translates to an inflation-adjusted yield of -0.45% against the current 2-year breakeven inflation expectations rate of 1.72%.
The 12-auction averages for the 2-year are: 2.82 bid cover ratio, $167 million in non-competitive bids, 3.7 bp tail to the median yield, 17.9 bp tail to the low yield, and 58% taken at the high yield. The 2-year is the least popular coupon security among foreign investors and central banks. Indirect bidders, a proxy for foreign buying, have taken an average of only 42.1% of the last twelve 2-year auctions, well below the average of 59.2% for all recent Treasury coupons.
