Tonight’s the night – as they say.
Donald Trump will deliver his highly anticipated speech to Congress on Tuesday evening and markets will be transfixed. In recent days we’ve seen Treasury yields hit YTD lows as investors and traders fade the reflation narrative even as stocks explore dizzying heights.
As discussed at length here on Sunday and Monday, Trump will need to walk a fine line between delivering something concrete and overpromising lest he should spark a flight to safety in USTs that could be exacerbated by short covering.
And it’s not just Treasurys you’ll need to watch. The yen has been marginally bid of late and there’s a very real possibility that USDJPY could come under immense pressure if the President disappoints.
With that as the backdrop, consider the following preview from Citi.
President Trump’s speech this evening is likely to offer only limited guidance on fiscal issues and so contains limited upside risk for yields. Notably, President Trump yesterday reduced expectations on a big announcement, saying that a tax plan is not possible until health care reform costs are known. An official spokesperson added that Trump’s first budget would not address taxes or mandatory spending. Instead, Trump offered up comments that he will have a big statement (“big league”) on infrastructure in his Tuesday speech while also commenting on a US$54bn rise in military spending offset by cuts to discretionary spending.
The general tone of the speech should continue to follow his pro-growth and UScentric script with the key themes including (1) post-inauguration accomplishments, (2) fiscal policy aims; and (3) upcoming foreign policy actions. Trump-watchers will probably have to wait for the forthcoming White House/OMB budget for specific details on the President’s tax reform and spending agenda. The budget is tentatively scheduled for release on March 13.
- The absence of detail is not yet worrying markets but there has been a perceptible shift in markets on the stimulus effect. Figure 1 shows 10Yr Treasuries against the US stock market Cyclical-Defensive ratio. The euphoric Cyclical versus Defensive stocks has corrected from the highs and is consistent with the rally in Treasuries. (Figure 2 shows the same for Germany). That contrasts with the new high in US stocks.
- Why is the market less euphoric? The absence of clear policy is one factor but there is also the issue of the border tax adjustment (BTA), where sentiment has been shifting in recent weeks. Markets are revising down the probability of the BTA being implemented given the opposition from several GOP Senators and given that the BTA was the main tool for raising revenues to fund a general corporate tax cut this infers that markets are also beginning to price in the risk of lower net stimulus effect.