Sept 27. Bond bubble meets tax reform pin?
–Those that consider the bond market in a bubble are seeing vindication this morning as yields jump, with TYZ at a new low 125-14 and the ten year nearing 2.30% (up nearly 7 bps from yesterday). With the health care vote tabled, attention has shifted to a rapid implementation of tax reform. According to Bloomberg, “The rate on corporations would be set at 20 percent, down from the current 35 percent, and businesses would be allowed to immediately write off their capital spending for at least five years.” The eurodollar curve is slightly steeper from rock bottom levels. For example, yesterday the red/gold pack spread settled at a new low of just over 40 bps and is currently around 45.
–There was heavy trade yesterday in some of the one-year calendars. For example, EDU18/EDU19 traded over 50k and settled 19. EDZ18/Z19 traded 40k and settled 16.0. What has been surprising is steepening of near spreads relative to the back end of the curve. For example, EDZ17/Z18 is 33.5 and Z18/Z19 only 16, so that butterfly is 17.5. Certainly, gov’t spending related to storm rebuilding will give the economy a short term boost (reason for near spreads to widen?), but the longer term impact of increased capital spending and increased bond issuance while the Fed trims reinvestment makes the extreme flatness along the back end of the curve puzzling at best. There isn’t even one hike per year being priced. One might even call it a mystery (as Yellen is fond of phrasing the current lack of inflation). However, that mystery may end up being solved in dramatic fashion. Some of the curve shape will depend on how a new Fed responds to a change in fiscal policy. However, back spreads appear too cheap if a tax plan as outlined can pass.
–Quick anecdote about price pressures. A friend whose family is involved in agribusiness and owns a grain elevator says that every year they construct a new bin. For the previous two years, price increases were about 5%. This year it was an 8% increase. Oh, you might say that’s just a one-off story and unimportant. But it’s at least as important as this snippet from Brainard yesterday regarding labor market wage disparity: “Another possibility that is increasingly in focus is that physical disabilities, as well as sharp increase in opioid use, have increasingly inhibited some individuals from participating in the labor force.” I think I’ll focus on price pressures related to basic needs…
