The bond market is wrestling with the Trump trade — and could continue to do so until the incoming administration and Congress can provide more details about their programs — particularly tax reform.
Buyers have been piling into Treasurys, sending prices higher and yields lower against a wall of uncertainty. At the same time, there is a giant short position, which can also help send yields lower as investors cover.
The Treasury market, particularly at the long end, has been attracting buying for a variety of reasons — one of which is the lack of clarity around the same programs of President-elect Donald Trump that drove yields sharply higher in the weeks after Election Day.
Traders are hoping for some clues when Trump holds his first news briefing since winning the election.. The news conference is expected to be at 11 a.m. Wednesday
"To be fair, there isn't a great deal known about the event—but presumably the President-elect will be fielding policy-relevant questions from his perch at the Trump Tower. It's not the inauguration, so we're doubtful it will be scripted or over-polished; which sets up the event to be more tradeable, if not necessarily insightful on the specifics of his initial plans while in the White House," writes Ian Lyngen, BMO head of U.S. rate strategy.
Another reason investors are jumping into bonds is the uncertainty about what is going on with China's volatile currency. There is also higher demand for Treasurys by investors who are hedging corporate bonds, and corporate debt issuance in the first five trading days of the year was a whopping $62 billion for investment grade debt alone.
But Treasury strategists see the Trump trade as an important theme, now that the 10-year yield has retraced from its post election high of 2.64 percent on Dec. 15 to 2.36 percent Monday. On Tuesday, the yield was barely changed at 2.37 percent.
"Obviously we had strong corporate issuance. To start the year with that kind of a bang is very unusual. It's weighing on yields. The 10-year was at 1.60 before the election. Even at 2.35, it's 75 basis points higher. A lot of this is based on forward expectations of the new administration's policy," said Boris Rjavinski, rate strategist at Wells Fargo. "Some of the policies could be implemented very quickly. Some could involve protracted fights."
Goldman Sachs economists, in a note, said they expect the tax reform process to begin in March or April in the House of Representatives. They expect the House proposal to include "border adjustment," or a tax on imported goods, as well as limitations on what interest corporations deduct. But the outlook for other issues is less clear, they wrote. That would include infrastructure spending and trade policy, including possible tariffs.
"The pace of implementation is now beginning to be questioned to some extent, and I don't think anyone is really doubting we will get tax reform or fiscal stimulus, visa vis lower tax rates," said Mark Cabana, head of short end rate strategy at Bank of America Merrill Lynch.
So now that the trade has tired, the next catalyst could be new information on when Congress will begin to work on different aspects of the programs. Traders were watching the meeting Monday night, between Trump son-in-law Jared Kushner and other incoming White House officials with House Speaker Paul Ryan and his team on tax reform.
"We are in a big wait and see mode as to how policy will be implemented in the near term," Cabana said.
Cabana said the market has been watching how the new Congress has been dealing with repealing Obamacare, its first act of the new session. "There may be some defunding, but there's not a clear path of what it will be replaced with," he said.
Economists have not built much extra growth into their 2017 forecasts from the Trump programs, though markets were lifted in a "reflation" trade on the hope that the economy would be boosted. The overhaul of corporate taxes was a big factor behind the optimism that has driven the Dow about 9 percent higher since the election, and there was hope that Congress and the White House would agree to a plan this year.
"Those micro details are definitely starting to permeate the conversation," said George Goncalves, head of rate strategy at Nomura. "I'm amazed it took that long, but there was a lot of hope and excitement around it. It's a new year."
In the weeks after the election, stocks rallied, the dollar gained and bond yields rose as traders viewed the combination of a Republican Congress and Republican White House as a strong setup for quick passage of tax and regulatory reform and fiscal stimulus. But in recent sessions, the market has watched every development in Congress with more interest than usual.
"We're setting up for some showdown in the Senate with Cabinet-level confirmation hearings. That has reduced slightly some of the optimism that we would see something happen quickly in the second half of the year," said Cabana.
On Tuesday, markets will also keep an eye on the confirmation hearing of Sen. Jeff Sessions for Attorney General. There is also a hearing for retired Marine Gen. John Kelly as Homeland Security secretary.
The confirmation hearing of former Exxon CEO Rex Tillerson as Secretary of State is scheduled for Wednesday. The hearing will be concurrent with Trump's first news briefing since the election.
"There could be something interesting coming out of the hearings and his press conference. They're forcing us to multitask," said Art Hogan, chief market strategist at Wunderlich Securities. "Where the 10-year was — that was a pretty significant move in a short period of time. Some of that moderation we're seeing is not just happening there. It's happening in the financials."
Financial stocks have led the market higher since Election Day, with about a 17 percent gain. The S&P financial sector slid 0.8 percent Monday. Hogan said the pattern was also the same in what was a broader reflation trade.
Stocks opened mixed but moved higher Tuesday, with the Dow and the reversing some of Monday's losses. The Nasdaq, after closing at a record Monday, was higher again, helped by Illumina and Intel.
"All of the real rapid rotation trades needed some relief and to take a breather here. The real thing to me is they're being replaced by something else. When the financials pulled back here with the 10-year, tech and health care jumped in significantly," Hogan said. Financials had been rising on the idea that interest rates would be going higher and could move higher even more quickly, if Trump's programs spark economic growth and inflation.
Goncalves said Treasurys have also benefited from some of the contradictions around the proposals. For instance, the idea of a border tax may harm the corporate supply chain and that would not be positive for growth.
"Because they're not fleshed out, they're inconsistent. They want a stronger dollar, but that's bad for manufacturing. How do you square all these things?" he said. "Some of the macro implications of changing how business is conducted itself falls into the uncertainty category for sure."
Besides watching Congress Tuesday, there is some data including JOLTs, job opening data and wholesale trade, both at 10 a.m. There is also NFIB small business survey at 6 a.m.
There is also a $24 billion three-year note auction at 1 p.m. ET Tuesday, the first of three auctions this week. The 10-year and 30-year auctions would be more important Wednesday and Thursday.
"I think the uncertainty factor around all this stuff also helps bring back more money into Treasurys," Goncalves said.
He said the auctions could be like a "litmus test" for the market, and while they could support rates, he said yields could be even lower after the inauguration, as the markets sort out what the new administration will do.
"The U.S. economy and global economy has worked so hand in hand, that that's going to cause friction … and that could raise risk premiums, and draw a bid for Treasurys. That may be what's happening as well," he said.
"They've been letting the currency slowly weaken. A weaker dollar would help stabilize the China situation because they are so dollar pegged," Goncalves said. The currency has been volatile in both directions lately. "It was a controlled kind of weakening of the currency in response to both the outflows and speculative behavior that was happening as well."