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The Daily Prophet: Bond Market Discounts Trump Tax Plan, Bigly

Connecting the dots in global markets.

If you really want to know about what Wall Street thinks of the Trump administration's sparse tax proposal and its chance of succeeding, just take a look at today's auction by the Treasury Department of $28 billion in seven-year notes. Most economists say the broad ideas described in the one-page plan would result in a much wider federal budget deficit down the road. That means a lot more bond sales to finance the shortfall between government revenues and receipts.

Yet, bond traders couldn't get enough of the debt at the auction, with demand being the highest since 2012 for that maturity based on the amount of bids received relative to the amount that was offered. Strategists described the auction as "steamy" and "off-the-charts strong." That's hardly the result one would expect to see if bond traders felt the plan had any shot of passing, at least in its current form. After all, this is a group known for driving up borrowing costs for governments in response to policies they view as fiscally irresponsible, garnering them the nickname bond vigilantes. Then President Bill Clinton was forced to abandon his stimulus plans in 1994 because bond yields soared amid concern they would cause the deficit to soar.



True, deficits have hardly mattered in recent years, in part because of the Federal Reserve's huge bond-buying program. Even so, there are any number of metrics that suggest bond traders see very few risks on the horizon that would push yields higher, according to Bloomberg News' Brian Chappatta and Liz Capo McCormick. “Bond vigilantes are now clearly showing no signs of vigilantism,” said Edward Yardeni, president of Yardeni Research, who’s been following the market since the 1970s and coined the term “bond vigilantes” in the 1980s.

OIL ROCKED BY SUPPLY CONCERNS - AGAIN
Of course, there are plenty of reasons why bonds are in demand, and the renewed slump in oil is one of them. Crude is back below $50 a barrel, easing concern that rising energy prices would add to inflation and diminish the value of fixed-income assets. Today's drop in oil came as Libya reopened its biggest field and as the market weighs increases in U.S. product inventories and crude output, according to Bloomberg News' Jessica Summers. Oil has declined over the past two weeks amid concern rising U.S. output will offset efforts by the OPEC and its allies to trim a global glut. Russia, which joined the bloc in cutting production in the six months to June, may find it more difficult to extend the deal as that would constrain plans by local companies to expand. Russian Energy Minister Alexander Novak said this week his country will wait to decide on joining OPEC in prolonging the output curbs.



AIRLINE SHARES TAKE A BEATING
Lower oil prices usually benefit airline shares. Not this time.  American Airlines Group sent industry stocks reeling after unexpectedly granting pay raises to pilots and flight attendants -- a move seen as weakening the case that carriers are poised to generate steady profits, according to Bloomberg News' Mary Schlangenstein. The pay bumps will add $930 million in costs through 2019, American said. CEO Doug Parker reversed his earlier opposition to increasing compensation before labor contracts expire, following months of pressure from employees who argued they were falling behind counterparts at rival carriers. Stepped-up compensation at the world’s largest carrier is fueling doubts about airlines’ ability to avoid spiraling costs and capitalize on industry consolidation that’s supposed to lead to steady returns after decades of boom and bust. 



DRAGHI DELIVERS SURPRISE TO EURO TRADERS
The European Central Bank delivered a nasty surprise to currency traders who had been bidding up the euro in anticipation that President Mario Draghi would adopt a more hawkish-sounding tone in the wake of some pretty encouraging economic data out of the region. Draghi said that even amid the progress in growth, “underlying inflation pressures continue to remain subdued and have yet to show a convincing upward trend.” As if that wasn't enough to hammer home the point, the official policy statement said that policy makers didn’t discuss changes to their forward guidance which says that rates will stay at present or lower levels for an extended period. Then again, the ECB certainly doesn't want to see the euro get too strong right now and weigh on the budding recovery given the French presidential elections, Italy’s political limbo and Brexit negotiations with the U.K.



MORE CHINESE RED FLAGS
Chinese companies seeking to sell bonds are suffering from the government's crackdown on investors seeking to put their money into risky assets. The extra yield that investors demand to hold top-rated bonds instead of sovereign debt surged to 1.5 percentage points this week, the most since April 2015, according to Bloomberg News' Tian Chen. China's intensifying efforts to reduce leverage have driven the overnight money-market rate to a two-year high this month and made the nation’s equity benchmark among the worst performers in the world. The nation will control leverage ratios and conduct comprehensive checks on financial markets and Internet finance, President Xi Jinping said at a meeting of the Communist Party Politburo Tuesday, according to the Xinhua News Agency. The increased scrutiny of late was seen prompting banks to pull so-called entrusted investments -- funds that lenders farm out to external asset managers.

 

TEA LEAVES
The U.S. Commerce Department releases its estimate of first-quarter gross domestic product Friday and it's not likely to be very pretty. The median estimate of 80 economists surveyed by Bloomberg News is for a reading of 1 percent, and even that may be too optimistic. The economists at JPMorgan Chase cut their forecast to 0.4 percent following the government's annual revisions to its retail sales data this week. First-quarter growth has tended to be weak in recent years, and the economists at Bloomberg Intelligence see GDP accelerating to a 2.7 percent rate in the second quarter amid solid household income gains and high consumer sentiment readings. Here’s hoping.

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Donald Trump's Misguided Approach to Tax Reform: Editorial

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