Top of the Street: A march, a mystery, a BEATing on taxes and more

The Fed takes a dovish final bow. LIBOR jumps as banks temporarily trim lending. Tax reform could BEAT foreign banks. DQs rise in PR. And a read on politics and economics. Contributions from Barclays, JPM, MS, NY Fed and Milepost.

Markets: The Fed marches on. Cautiously.
The Fed last week hiked as expected and raised the cap on monthly portfolio runoff, but concern about inflation led it to signal only three more hikes in 2018. Some analysts had expected four. The Fed’s had an upbeat take on both the labor market and economy seemed less convinced that inflation will move closer to the 2% target. Core inflation for November came in at a weak 0.12%. Core PCE inflation is likely to come in this week at a year-over-year pace of 1.5%. Chair Yellen also so made some notable comments that future yield curves could be flatter or more frequently inverted than in the past. See JPMorgan, US Fixed Income Markets Weekly: Economics, 15 Dec 2017. See also Morgan Stanley, Global Interest Rate Strategist, 15 Dec 2017. (JPM, MS, Milepost).

Markets: LIBOR’s mysterious rise
The cost of short-term funding almost always rises at the end of each quarter as banks trim lending to reap a wide range of benefits from a smaller balance sheet, but the rise this quarter is especially sharp. LIBOR and other funding rates have jumped even after accounting for the recent Fed hike, and sharp cuts in lending from the eight US global systemically important banks may be to blame. These banks will have to set aside a capital surcharge in 2019 based on their balance sheet at the end of 2017. The capital surcharge depends on a score that includes size, complexity, international activity, connections to the rest of the financial system and short-term wholesale funding. Many of these banks are on the edge of scores that would push up their capital surcharge by 50 bp, so there is clear incentive to pull back. Reducing funding is one flexible way. Steady demand for funds with falling supply has pushed up rates, but that will likely reverse after the New Year. See JPMorgan, Making sense of Libor’s mysterious rise, 14 Dec 2017. (JPM, Milepost).

Markets/banking: Tax reform could BEAT foreign banks
Measures in the pending tax reform bill designed to stop a form of tax arbitrage could hurt foreign banks’ business in the US. The measure, the Base Erosion Anti-Abuse Tax or BEAT, targets the strategy of having a parent in a low-tax country make a loan to a US affiliate that allows the affiliate to deduct interest and reduce taxable income. Under the Senate version of BEAT, a bank’s gross interest payments to a foreign parent or affiliate would trigger an additional tax. The Institute of International Bankers or IIB, representing foreign banks in the US, has argued for the House version, which would tax the smaller net interest payments to foreign affiliates. The IIB argues that the Senate version is punitive and would hurt foreign bank lending, especially in the repo market where eight of the 10 largest lenders are foreign banks. JPM, US Fixed Income Markets Weekly: Short-Term Fixed Income, 15 Dec 2017. (JPM, Milepost).

Markets/economy: Puerto Rico’s homeowners roll further into delinquency
While an initial wave of mortgage delinquencies after Hurricane Maria appears to have peaked, a rising share of Puerto Rico’s homeowners are rolling further past due. The share of Puerto Rico loans running 30 days delinquent surged from less than 5% before the storm to 22% in October before dropping to 9% last month. Loans running 60 days delinquent jumped from 5% in October to 16% last month. And loans 90 days delinquent jumped from 3% before the storm to 7% last month. This is all based on Ginnie Mae data. Tax reform also may add to the pain. Both House and Senate versions included a foreign import excise tax that would apply to Puerto Rico manufacturers exporting to the US. That could squeeze the island’s economy. See JPM, US Fixed Income Markets Weekly: Agency MBS, 15 Dec 2017. See also Barclays, Municipal Weekly: Rate Hikes and Tax Cuts, 15 Dec 2017. (Barclays, JPM, Milepost).

Markets/economy: Politics shapes expectations but not economics
The last presidential election improved both Democrat and Republican expectations about household finances and the economy but had no detectable effect on actual spending so far, according to a newly released NY Fed study. Counties that voted Democrat generally had a more optimistic outlook before the election, but optimism in counties that voted Republican surged ahead after the election. Expectations have fallen since, especially in Republican counties. Nevertheless, “the election had little partisan impact on spending,” according the the NY Fed. The NY Fed study is here. (NY Fed, Milepost).