The bond market is in the process of stomping out all optimism about the Republican pro-growth agenda and is preparing for a long drawn-out drama surrounding President Trump's latest controversy.
Treasurys staged their second-biggest rally of the year Wednesday, as expectations faded that Trump can get tax reform or fiscal stimulus through Congress this year, or maybe even next year.
After a rash of brushfires, the latest controversy — involving the president's alleged request to end an FBI investigation — looks to be a long-burning wildfire, which will be harder to contain.
"You're reducing your odds on any timing and eventuality. [Tax reform] certainly is going to be later, if at all," said John Briggs, head of strategy at NatWest Markets.
"Not that it won't happen, but this has the markets saying that there's more potential for this to be a political crisis than other events so far," he said. "It's hard to see a Senate-House conference on health care being called."
The reports that Trump had asked former FBI Director James Comey to end an investigation into former national security advisor Michael Flynn also sent stocks into a tailspin Wednesday, as some Democrats called for impeachment and Republicans said they wanted to hear from Comey.
"In my mind, the market's making a judgment that this is not going to be a passing political, minor road bump. The market seems to be telling me that it's more than minor," said Briggs.
The 10-year Treasury yield fell about 11 basis points to 2.21 percent, in its biggest move since April 21. Yields move inversely to price. The fell 43 points, or 1.8 percent, to 2,357. The Dow was down 1.8 percent, and the Nasdaq was down 2.6 percent at 6,011 as stocks closed the session near their lows.
Strategists say the 10-year could find support near 2.15, and another leg down could take it to 2 percent, a level last seen Nov. 10.
Wednesday was the first time stocks reacted strongly to Trump. But in the dollar and bond markets, earlier in the week there was clear concern about Trump becoming ensnared in controversy, on reports he passed along classified information to Russia.
"I think they're worried this is going to be a longer-standing event. They think there's very small chance now of tax reform," said Art Cashin, director of NYSE floor operations at UBS.
The bond market has already been pricing out any economic positives from Trump for months now, while stocks had been holding out hope that Congress could get to a tax-cut package before the end of the year. The market is also betting, based on the same concerns for growth, that the Fed will only hike once this year, instead of the two hikes it has forecast.
"It's really ultimately a risk nothing gets done," said Mark Cabana, head of U.S. short rate strategy at Bank of America Merrill Lynch.
The consensus is that the Fed will hike next in June, but Cabana said he has been expecting the Fed to skip June and cut rates later. He said the Trump controversy could affect the thinking of some officials.
"Some Fed officials have put fiscal stimulus in their forecast. For those that have, if this drama continues and there is a lack of progress on that domestic agenda I would imagine they would have to adjust that," he said.
There was also concern in the bond market that a steeper sell-off in stocks could tighten financial conditions and that would make the Fed hold off on rate hikes.
Strategists expect the negative mood to hang over markets. "I can see a scenario where a headline moves us 10 basis points lower in yield, but it's hard to see a scenario where a headline moves us 10 basis points higher," said Aaron Kohli, director of fixed income strategy at BMO Capital Markets.
All of this makes the economic data more important, bu there is little for markets to consider this week.
On Thursday, the Philadelphia Fed survey is released at 8:30 a.m., as are initial claims.
Cleveland Fed President Loretta Mester speaks at 1:15 pm ET in Minneapolis.
Earnings are expected from Wal-Mart, Alibaba, Ralph Lauren and Burberry Thursday morning. Applied Materials, Salesforce.com, McKesson, Gap, Ross Stores and Autodesk report after the bell.