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. 

Morning Report: Tax reform is on the agenda this week

Vital Statistics:

	Last	Change
S&P Futures	2496.8	-2.8
Eurostoxx Index	383.9	0.7
Oil (WTI)	51.2	0.5
US dollar index	85.8	0.3
10 Year Govt Bond Yield	2.25%
Current Coupon Fannie Mae TBA	103.24
Current Coupon Ginnie Mae TBA	104.21
30 Year Fixed Rate Mortgage	3.85

Stocks are down small this morning on no real news. Bonds and MBS are flat.

We have a decent amount of economic data this week, along with a lot of Fed-speak. The big economic news will be the final revision to second quarter GDP and the personal income and personal spending releases. Janet Yellen speaks on Tuesday. 

Economic activity slowed in August, according the Chicago Fed National Activity Index. The index fell from 0.4 to -.31, for the lowest reading in a year. Production-related indicators drove the decrease. Employment-related indicators were a mild positive. 

The Trump Administration is going to push for tax reform this week. The highlight is a cut in the top rate to 35% and a cut in the corporate income tax to 20%. The cut in the top rate will be paid for in part by limiting deductions for state and local taxes. Chuck Schumer has insisted that "not one penny" of tax cuts go to the top 1%, so that could make the plan doomed. The estate tax will also get the axe. Republicans are working on the procedures to pass this without Democratic votes. 

Meanwhile, Obamacare repeal and replace looks like it is going to go down as well. 

We are starting to see some of the fallout from the recent hurricanes: Homebuilder D.R. Horton cut its cash flow forecast by 50%. Lennar has also said that the hurricanes will delay deliveries. At the end of the day, there is such high demand for homes that this should be a 1 quarter effect which will be made up in following quarters. 

Lenders are easing standards given the increase in interest rates and the corresponding drop in volume. “Lenders further eased home mortgage credit standards during the third quarter, continuing a trend that started in late 2016. In particular, both the net share of lenders reporting easing on GSE-eligible loans for the prior three months and the share expecting to ease standards on those loans over the next three months increased to survey highs," said Doug Duncan, senior vice president and chief economist at Fannie Mae. "Lenders’ comments suggest that competitive pressure and more favorable guidelines for GSE loans have helped to bring about more easing of underwriting standards for those loans. We believe that the GSEs’ attempts to relieve repurchase concerns and expand credit for creditworthy borrowers have contributed to the easing trend. Meanwhile, market competitiveness also led to the fourth consecutive quarter in which lenders’ net profit margin outlook deteriorated. The share of lenders citing competition from other lenders as the key reason for a negative profit market outlook rose to a new survey high.”