Learn from the Past
Mortgage backed securities (MBS) lost 11 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move slightly higher for the week.
It was a very light week for economic data as there was not a single economic release that had the gravitas to move the needle on rates. There was also a shortened trading session with the bond markets closed on Friday in observance of Veteran’s Day.
Two Key Areas
The bond market focused on two key areas: (1) The Fed and (2) Tax Reform. Both gave the bond market more uncertainty.
(1) The Talking Fed: N.Y. Fed President and FOMC Board Member William Dudley announced that he will be retiring a couple of months early. The term limits are for 10 years and he was slated to hit that in early 2019. He said he would retire in “mid-2018” instead and that the exact timing will be determined by making sure that his replacement is all set before he leaves office.
(2) Tax Reform: The Senate Finance Committee Chair Orrin Hatch released the Senate’s updated tax proposal. It had several key differences from the House Bill.
Here are the most notable highlights:
• 20% permanent corporate tax cut delayed by 1 year
• Complies with the $1.5 trillion cost (will cost $1.44 trillion)
• Preserves 7 tax brackets: top tax bracket is 38.5%, down from 39.6%
• Doubles standard deduction from $12,700 to $24,000 (married couples)
• Ends state and local tax (SALT) deduction; keeps business deduction
• Keeps the mortgage Interest deduction cap at $1 million
• Preserve the estate tax, doubling the current $5.49 million exemption for individuals
• Raises the child tax credit to $1,650 from $1,000
• Sets 10% tax rate for US companies with IP in foreign low-tax jurisdictions
• Full expensing of capital investments for five years
• Preserves 401(k)s IRAs
• Sets repatriation rate at 12% for liquid assets, 5% for illiquid assets
• Carried interest loophole unchanged
• Electric Vehicle tax credit is spared
What‘s on the agenda for this week?
Tax reform continues to be the story to watch this week as any increase in probability of something moving forward (with enough cuts to stimulate the macro economy) will pressure pricing but any type of stalemate in the Senate will keep MBS moving sideways at very lofty levels. CPI will need to be closely watched but it is unlikely to be soft enough or strong enough to influence the bond markets hedging for a December rate hike. The upside for MBS is going to be very tough and the downside is low too unless Tax Reform has 50 votes (plus Pence tie breaker) in the Senate.
The three areas that have the greatest ability to impact backend pricing this week are: (1) Tax Reform, (2) The Talking Fed and (3) Domestic Flavor.
(1) Tax Reform: The Senate begins the mark-up of their version of the Tax Bill. Currently the bond market is not putting a high probability of Tax Reform passing any time soon given at least three Republican Senators have come out against any type of reform that adds to the deficit. Any change in sentiment among those three Senators and/or movement in the Senate and House will impact pricing as bonds are very reactive to any type of macroeconomic stimulation such as lower corporate taxes and the repatriation of cash from overseas.
(2) The Talking Fed: The watch is on for a December rate hike. But any news/leaks on prospects to fill the four open Fed Governor positions will also get a lot of traction.
11/13 Patrick Harker
11/14 Charles Evans and James Bullard
11/15 Eric Rosengren
11/16 Loretta Mester, Robert Kaplan and Lael Brainard
(3) Domestic Flavor: Inflation will take center stage as both the Producer Price Index and Consumer Price Index will be this week. The higher the YOY readings are, the worse it is for rates. The lower the readings are, the better it is for rates. Retail Sales will also be a very key reading.
Other than the monthly bond coupon rollover, nothing really happened today that had any impact on pricing (thus the zero BPS change so far). There were no major economic releases and no major movements in Tax Reform today.
The Talking Fed
Philadelphia Fed President Patrick Harker (voting member) said he has “lightly penciled in” a December rate hike. However, he also said that he had slightly less conviction about the policy decision than he had last month as he continues to “elicit caution” about weak inflation and about the way in which it is measured.
Treasury Budget: The October budget deficit came in at $63.42 billion, which is 37.9% larger than the $45.8 billion deficit in October 2017. The larger deficit reflects an 11.6% increase versus October 2016 in outlays to $298.6 billion that outpaced a 6.2% increase in receipts to $235.3 billion.
Tax Reform: President Trump tweeted that he now wants to add back in the provision that will remove a tax penalty for not signing up for Obamacare in the House Bill. The House was hoping to push through their version of the tax bill this week. Meanwhile, the Senate is trying to see if there is even enough support to have a vote on their version.
On Deck for Tomorrow: Producer Price Index, The European Central Bank’s Draghi, Fed’s Yellen, Bank of England’s Carney and Bank of Japan’s Kuroda are all scheduled to participate on a policy panel hosted by the ECB which will be very closely watched.