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19th of January 2018


Treasury yields and stocks rise after tax cut progress

Michael Hunter

December 20, 2017

Investors were cutting their exposure to government bonds and buying stocks at the start of US trade as they considered the potential impact of Republican tax cuts on the outlook for inflation and monetary policy.

The $1.5tn package was facing a clearer path to the statute book, with growing expectations that it would be ready to be signed into law by President Donald Trump before the end of the year.

US government debt yields are climbing, as a flurry of selling in the Treasuries market once again takes hold. Bond yields tend to rise when investors expect inflation to climb, as investors factor in the erosion of returns from debt holdings posed by inflation.

Benchmark 10-year Treasury yields were up 2.5 basis points at 2.49 per cent, having risen 7bp during the previous session, leaving it around its highest level since March. The yield has struggled to hold consistently above the 2.4 per cent mark during 2017, constrained by the established trend for low US inflation data.

The more policy-sensitive two-year US bond yield is up 1.2bp at 1.86 per cent.

The S&P 500 started Wednesday’s session up 0.3 per cent, as did the Dow Jones Industrial Average, with both benchmarks just shy of Monday’s records.

The Federal Reserve’s rate-tightening cycle has been constrained by sluggish inflation, and any sign that it could rise towards the central bank’s 2 per cent target will be closely watched. The Fed’s preferred measure of inflation read 1.4 per cent in November.

Andrew Hunter, US economist at Capital Economics, predicted four rate rises from the Fed in 2018, adding: “We expect the fiscal stimulus to contribute to a steady rise in inflation over the coming quarters.

“At this stage of the cycle, the stimulus could end up boosting inflation by more than it boosts growth.”

Market opinion on the prospects of the fiscal stimulus to affect inflation was expected to define near-term reaction among investors, although there were also warnings that much of the potential influence of the measures had already been priced in.

“We would play the passage of the tax cuts through global equities first, over US equities, but through US equities more than the dollar,” said Mark Haefele, global chief investment officer at UBS.

“The tax bill is polling poorly in the US, but its popularity will rise if Republican claims that real Americans will see its effects come through in their pocketbooks, and that will help underpin strong US consumer sentiment.”

The index tracking the dollar against six main rivals stood at 93.930, leaving it 2.2 per cent above its September low point for 2017.

Derek Halpenny, European head of global market research at MUFG, warned of the risk of “a buy the rumour, sell the fact reaction” on US equity markets to the passage of the cuts.

“The S&P 500 is up 26 per cent since Trump’s election victory and this is the one market that has very much been driven by corporate tax cut expectations and with that now confirmed, a correction is an increasing risk. That would likely dampen US yields and undermine the dollar.”

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