Despite Korea and low inflation, US 10-year rates should still rise toward 2.35%. Hurricane Harvey should dent 3Q GDP but raise 4Q. Houston housing should take a big hit from Harvey, too. Tax reform could cut muni demand. Contributions from BAML, Barclays, MS and Milepost.
Markets: Room for rates to bounce higher
Tension with North Korea still has potential to trigger a flight to quality, but a few slightly more predictable forces incline toward marginally higher US rates. Harvey has tilted Congress toward lifting the US debt ceiling and passing a FY2018 federal budget on time, removing some of the political risk that built through August. The Fed looks set to formally announce tapering of its portfolio this month and start operations in October. The European Central Bank also looks headed cautiously toward an end to QE. Street economists lately have been revising projected 3Q GDP higher. There’s still risk that persistent low inflation could push the Fed’s path lower. Fed Governor Brainard said in a speech this morning that “We should be cautious about tightening policy further until we are confident information is on tract to achieve our target.” Absent Korea and inflation concerns, 10-year rates should migrate back toward 2.35% through the fall. (Milepost).
Economy: Houston, we have a problem
First comes the disaster, then the reconstruction. First the dip in the local economy, then the rebound. The Houston metro area accounted for 3.2% of GDP in 2015, according to Bank of America, so a 10% drop in activity would cut GDP by 0.3%. A long break in natural gas, oil and chemical production could knock 1 to 1.5 percentage points off 3Q GDP, according to Barclays. The most likely timing would be a dip in 3Q17 and a rebound in 4Q17. Research is mixed on the net effect of economic disaster. It depends on whether the damage is simply repaired or if the broader infrastructure is improved. That tends to swing the needle fro net negative to net positive. See Bank of America, US Economic Weekly, 1 Sep 2017. See also Barclays, Global Economics Weekly, 1 Sep 2017. (BAML, Barclays, Milepost).
Markets: Harvey’s silver lining
Political brinksmanship over the looming US debt limit and a shutdown of the federal government now looks less likely with Washington focused on hurricane relief. The White House on Friday asked for $7.9 billion in relief and pushed for an increase in the debt ceiling. Shutting down the federal government in October also would interfere with relief efforts. Public sympathy for a shutdown also has likely waned. Congress will need to approve more hurricane relief and reauthorize the National Flood Insurance Program by Sep 30. The market sees some risk that Congress passes hurricane relief without raising the debt ceiling, pulling a potential default into Sep. Yields on Oct 5 bills jumped 10 bp on Friday after news of the White House relief request came out. Goldman nevertheless expects the ceiling to get lifted and sees the probability of a shutdown going from 35% before Harvey to 15% now. See Goldman Sachs, Hurricane Relief Funds Likely to Pass Soon; Debt Limit/Shutdown Risk Declines Further, 1 Sep 2017. (GS, Milepost).
Markets: Residential credit risk comes ashore in Houston
Fannie Mae and Freddie Mac have sold large blocks of credit to private investors through credit risk transfers or CRTs since mid-2013, with metro Houston supplying between 0.94% and 3.05% of the loans backing these deals. In the month after Hurricane Katrina hit New Orleans, delinquencies there jumped from a low single digit to more than 40% and remained above 10% for another nine months. CRT investors potentially have to cover any loan losses once a loan goes more than 180 days delinquent. However, starting in 2014, language in Fannie Mae and, more clearly, Freddie Mac deals allow the agencies to make exceptions for loans delinquent because of natural disasters. See Morgan Stanley, CRT Exposure to Hurricane Harvey, 28 Aug 2017.
Markets: The muni market watches for tax cuts
The muni market is looking for a detailed tax reform proposal in early Sep that will likely change the appetite among corporate treasurers for muni debt. The proposal will likely come from the Big Six, a committee composed of House Speaker Ryan, House Ways and Means Chairman Brady, Senate Majority Leader McConnell, Senate Finance Chairman Hatch, NEC Director Cohn and Treasury Secretary Mnuchin. Hatch and Cohn have suggested recently that the corporate tax rate will fall to somewhere between 20% and 25%, not the 15% originally targeted. At a 25% tax rate, 10-year ‘AAA’ and ‘AA’ corporate debt would offer better tax-equivalent yield than similar muni debt. “P&C insurers (which are investing in shorter-dated bonds) might be less inclined to invest in munis,” writes Barclays analysts. “But, banks, which mainly invest in longer-dated bonds, are likely to still see good value in munis.” See Barclays, Municipal Weekly, 18 Aug 2017. (Barclays, Milepost).