Morning Report: Is the Trump Reflation Trade back? 12/20/17

Vital Statistics:

Last Change
S&P Futures 2693.3 -0.3
Eurostoxx Index 390.5 -0.5
Oil (WTI) 57.5 0.3
US dollar index 86.8 0.0
10 Year Govt Bond Yield 2.49%
Current Coupon Fannie Mae TBA 102.531
Current Coupon Ginnie Mae TBA 103.375
30 Year Fixed Rate Mortgage 3.88

Stocks are higher this morning as tax reform looks set to pass. Bonds and MBS are down.

The Senate passed tax reform, and it looks like we’ll need a second vote in the House because of the name. Stocks like it, and bonds are selling off. That said, bonds are selling off worldwide, so it isn’t just the US.

Hot on the heels of tax reform comes funding the government, as normal funding runs out on Friday.  Mitch McConnell has vowed there will be no government shutdown, and he is probably correct, as the continuing resolution will be larded up with all sorts of unrelated measures to garner the necessary votes. The big threat is if Democrats demand some sort of immigration deal or if conservatives balk at stabilizing Obamacare or re-authorizing CHIP. Politicians talk about “Christmas Tree” bills, where everyone gets an ornament (or a priority satisfied). Given the silence in the media and the absence of leaks, it appears that is exactly what is going on. Just in time for the season, I guess.

The 10 year broke through support yesterday, which caused a sell-off driven by stop-loss selling on the part of technical traders.  Don’t forget, one of the biggest trades on the Street right now is the yield curve flattening trade, where investors are long the 10 year and short the 2 year (or some variation of that). Yesterday, people got carried out on that trade as the losses on the 10 year side of the trade were not offset by gains on the 2 year. My point on this is that the movement in the 10 year over the past couple of days has a lot of noise in it, caused by temporary technical trading. It might just be a blip.

Does the passage of tax reform bring the Trump Reflation Trade back into play? The Trump Reflation Trade refers to the rally in stocks and the sell-off in bonds that we saw a year ago based on policy expectations in Washington. The markets were expecting a tax cut and an infrastructure spending plan which would goose the economy and drive investors out of safe assets like Treasuries into riskier assets like stocks and corporate bonds. That trade petered out, at least on the bond side of the ledger as getting anything passed in Washington looked almost impossible. We had a nice rally in bonds in Spring and have been stuck in a narrow range since. With tax reform now done, and talks of infrastructure spending next year, we could see a repeat, where bonds test the early 2017 levels around 2.6%. That said, I would be extremely surprised to see a deal on infrastructure, as 2018 will be all about midterm elections and posturing ahead of them.

The tax bill made some changes that are positive for housing and the mortgage industry. The biggest one for many smaller independent originators concerns mortgage servicing rights and the recognition of income for tax purposes. The original bill would have required originators to pay the tax up front for the MSR portion of the gain on sale. Since MSRs are not cash, it would have hurt the cash flows of many smaller originators and perhaps driven them out of servicing. The tax treatment for MSRs remains unchanged. Second, affordable housing advocates were worried about two provisions that would have possibly discouraged affordable housing construction – the removal of the Low Income Housing Tax Credit and Private Activity Bonds. Those provisions remain unchanged.

Mortgage Applications fell 4.9% last week as purchases fell 6% and refis fell 3% despite a drop in rates.

Existing Home Sales rose 5.6% to a seasonally adjusted annualized value of 5.81 million, which is the highest since 2006. The median home price rose 5.8% to $248,000. There are 1.67 million homes for sale, which represents about 3.4 month’s worth. The first time homebuyer was 29% of sales, and we saw cash-only sales (think investors) increase to 22%. The new tax bill will make it somewhat more attractive to be a landlord, so we could see some effect here, especially at the lower price points.

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