The Daily Prophet: Tax Talk Is Catnip for Stock Traders

Connecting the dots in global markets.

It's as if the Trump administration had figured out the secret to perking up gloomy stock traders: just mention that tax cuts are right around the corner. The S&P 500 Index reached its highs of the day Thursday, posting one of its biggest gains of the year, after Treasury Secretary Steven Mnuchin said the government is close to bringing forward major tax reform.

The move in stocks wasn't unlike what traders experienced on Feb. 9 when major indexes saw a huge bump after President Donald Trump told representatives of the nation’s largest airlines, air freight companies and airports that he would make an announcement on taxes in the next few weeks “that will be phenomenal." That never happened and traders had pretty much given up hope on anything happening with taxes this year. In fact, it was only yesterday that Mnuchin said the failure to repeal and replace the Affordable Care Act delayed the possibility of passing tax legislation by August, and even that goal was "highly aggressive to not realistic at this point.” 

The Trump administration is aiming to complete the biggest overhaul of the tax code since President Ronald Reagan by end of the year, even if a second attempt to repeal the ACA fails, according to Mnuchin. “Whether health care gets done or doesn’t get done, we’re going to get tax reform done,” Mnuchin said Thursday at a conference in Washington. “We’re pretty close to being able to bring forward what is going to be major tax reform.”

Mnuchin's comments reverberated through the markets, even helping the Bloomberg Dollar Spot Index erase most of its losses. The thinking here goes something like this: lower taxes will spur a spending boom by companies and consumers, which will finally lead to faster inflation. That will prompt the Federal Reserve to keep raising interest rates, bolstering the yield advantage that dollar-denominated securities have over the rest of the developed world and, thus, the appeal of the greenback. Fading optimism that Trump's policies would boost the economy can clearly be seen in the performance of the dollar this year. Through Tuesday, it was the biggest loser among the 10 developed-market currencies tracked by Bloomberg Correlated-Weighted Indexes, falling 2.56 percent. "The legislative agenda, as opposed to executive orders, is proving more difficult than many assumed given the Republican majorities" in the House and Senate, Brown Brothers Harriman strategist Marc Chandler wrote in a report Thursday. Even so, Chandler says the longer-term bull market in the dollar is intact and the advance will resume.  

The latest jawboning from Fed officials may prove Chandler correct. Despite the recent soft economic data, fresh comments from central bankers suggest they remain on course to raise rates twice more this year and are confident in their forecast for growth of around 2 percent. That’s a shift from the past, when they backed away from projected rate increases in the face of unexpected headwinds, according to Bloomberg News' Craig Torres, Rich Miller and Matthew Boesler. Now, the bar for delay is higher. “I still think the median of three rate increases for this year -- we’ve already done one -- is still a good baseline,” Dallas Fed President Robert Kaplan, who votes on policy this year, told Bloomberg Television’s Michael McKee in an interview Thursday. Investors are betting on just one more increase in 2017, prices of futures contracts linked to the benchmark overnight rate show. “It is appropriate to continue to be raising the short-term federal funds rate,” Boston Fed President Eric Rosengren said Wednesday. “The economy is strong enough to sustain that right now, even though I’d say that the recent data has been a little softer than I was expecting.”

Besides raising rates, the Fed is also starting to talk about reducing its balance-sheet assets before the year is out. That means it won't be reinvesting the proceeds from maturing bonds it holds into new securities. Naturally, that has caused a lot of consternation among bond investors who will be around to soak up the bonds the Fed will no longer be buying. The answer may be a bit surprising based on a chart sent to clients by Deutsche Bank Chief International Economist Torsten Slok, who found that U.S. companies have become big owners of U.S. government debt. Since the beginning of 2011, the combined holdings of Microsoft, Apple, Google, Facebook and have more than quadrupled to just over $200 billion. He says buying by companies are a key reason why bond yields remain so low even with the Fed raising rates.        

That cup of morning coffee may soon be a bit more affordable. U.S. warehouses are holding the largest amount of unroasted coffee since 1994, according to Bloomberg News' Marvin Perez, citing data from the New York-based Green Coffee Association of America. The surge in reserves, which include arabica and robusta beans, will probably help to keep a lid on prices, especially as demand traditionally ebbs during the coming warm summer months, said Hernando de la Roche, senior vice president for INTL FCStone in Miami. Arabica coffee for July delivery tumbled 4.5 percent to settle at $1.343 per pound on ICE Futures U.S. in New York after touching $1.3385, lowest for the most-active contract since Dec. 29. On Wednesday, prices sank 3.4 percent.

Friday is the last day for investors around the world to place their bets before French voters head to the polls Sunday to begin the process of choosing their next president. The four-way race includes one candidate who wants to pull France out of the euro and another who wants France to resign from NATO. Janus Capital calls it "the greatest source of uncertainty for markets this year." Bank of America strategists say that although hedging among investors has increased "sharply," that's mainly to protect against bets from being too cautious in case of a market-friendly outcome. "Markets still appear underpricing the risks," they say. Here's how the strategists at Barclays see things playing out: The win by independent Emmanuel Macron or center-right Republican Francois Fillon would be viewed positively in economic terms by markets, while the election of far-right National Front candidate Marine Le Pen or Communist-backed Jean-Luc Melenchon would trigger a period of financial turmoil and economic instability, which might require authorities to step in. Happy trading!

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