Morning Report: 401k plans won't be affected by tax reform

Vital Statistics:

	Last	Change
S&P Futures	2575.8	1.8
Eurostoxx Index	390.9	0.8
Oil (WTI)	52.0	0.2
US dollar index	87.2	0.2
10 Year Govt Bond Yield	2.38%
Current Coupon Fannie Mae TBA	102.875
Current Coupon Ginnie Mae TBA	103.938
30 Year Fixed Rate Mortgage	3.9

Stocks are up small on no real news. Bonds and MBS are flat.

Economic activity picked up in September, according to the Chicago Fed National Activity Index. Production, consumption, and employment indicators all improved. August and July were both weak, so the 3 month moving average is still negative, but within the range that shows the economy growing on trend. 

Congress continues to work on tax reform. Over the weekend, a trial balloon was floated that concerned limiting 401k contributions. This morning, Donald Trump tweeted that no changes in 401ks are being contemplated. Here is going to be the rub for tax reform. While the elderly were historically considered the "third rail" of American politics, in fact the real third rail is the upper middle class. Things like the mortgage interest deduction, 401k contributions, 529 college savings plans, etc are going to be almost impossible to eliminate. Obama tried to tinker with 529 plans and got nowhere. The state and local tax deduction is probably going to tough to eliminate as well, given that there is uniform Democratic opposition to any sort of tax reform, and there are enough blue state Republicans in the House who will see their constituents hit with higher tax bills. Donald Trump is so eager for a win, he will probably sign anything, and that "anything" will probably consist of a few marginal cosmetic things that won't amount to much of a change. It will allow everyone to claim victory and move on to the midterms. 

The prospect for tax reform is affecting interest rates. As we increase the probability of tax reform, rates are going to go up on the expected economic growth. If we end up getting some sort of symbolic tax reform, I wouldn't be surprised to see a "buy the rumor, sell the fact" effect. In other words, an increase in rates leading up to it, and then a drop as people digest the fact that it probably won't make much of a difference in growth. 

Trump said he will decide on the new Fed Head "very shortly." It is between Jerome Powell (the economists' choice), John Taylor (the conservative choice) and Janet Yellen (the liberal choice). This decision will be relatively apolitical, and will be nothing like when Obama was leaning towards Larry Summers and Elizabeth Warren led a vanguard from the left to nominate Janet Yellen. 

Ray Dalio of Bridgewater warns the Fed to not pay too close of attention to national statistics that are simply averages. As the economy bifurcates and the top 40% pull away from the bottom 60%, the effects of a recession will be borne more by those in the lower part. The punch line: the 4.2% unemployment rate probably overstates the strength of the labor market, and GDP growth overstates the growth of the economy. While he is correct on both points, the Fed doesn't seem to be in danger of overshooting and sending the economy into a recession. They are stepping very gingerly, and are de-emphasizing the unemployment rate in favor of wage inflation. Inflation is coming back in commodity prices (especially food), but that is almost invariably a temporary phenomenon.