With each passing day, the expectation that President Donald Trump can snap the economy out of a long period of sluggish growth fades, and the mood in the bond market gets more cynical.
"Generally speaking, the rally we've seen over the course of the last three weeks, or effectively, since the March FOMC meeting, has been a function of people rethinking Trumponomics and the potential for the administration to deliver anything in terms of real economic growth in the near to medium term," said Ian Lyngen, head of U.S. rates strategy at BMO.
The market has become worried that the president and Republicans will not be able to agree on pro-growth strategies, such as tax reform and government spending on infrastructure, that have helped boost the stock market. In the bond market, there is a concern that is a warning for stocks.
"The opposition that Trump has already started to see in Congress, whether it was in confirming his Cabinet and their recent pulling of the health-care bill, all of this suggests that the pro-business initiatives the market might have been expecting from Trump may have been delayed or permanently shelved," said Lyngen.
Strategists say the picture could change quickly, however, if there are strong economic data readings, including in Friday's jobs report. There would also have to be some signs of progress from Washington, after its recent failure to vote on eliminating and replacing the Affordable Care Act.
"The whole Trump trade, the reflation trade — the odds are, that's over. What we're seeing is there's no breakout trade of massive, upcoming fiscal stimulus," said Robert Tipp, chief investment strategist and head of global bonds and foreign exchange at PGIM Fixed Income. Instead, he sees Congress getting bogged down, and there's no clear direction of where policy is heading.
"If that's the case, what do we really have? We have the same economy we had six months ago, but with higher interest rates and a stronger dollar, and with a late-cycle economic situation, there's no upside. All of a sudden you're seeing peak auto sales," said Tipp.
Auto sales have been a pillar of the economic recovery, and on Monday, the monthly report may have sent a warning sign about consumers and the manufacturing sector. March vehicle sales were expected to come in at an annualized selling pace of 17.3 million but they fell to about 16.5 million. That was the first time sales were below 17 million since August, and they were well below the more than 18 million pace at the end of last year.
The number was another nail in the consumption outlook, after last week's disappointing consumer spending report for February. On top of that, the growth picture for the first quarter is dim, with economists seeing growth of just about 1 percent.
Treasury yields turned slightly higher Tuesday, as Trump spoke with CEOs, promising infrastructure spending and deregulation, but some strategists saw that as just a minor correction in the recent trend of lower rates.
Treasurys sold off sharply after the November election, when Trump promised he would launch a massive stimulus package and slash corporate and individual taxes. The number of traders with short positions surged, meaning, they expected bonds to continue selling off and interest rates to rise. But traders who were short have been getting out of those positions, and the preferred trade in Treasurys has been to buy.
Treasury short positions
Strategists say they are watching the threat by Senate Democrats to filibuster Judge Neil Gorsuch's Supreme Court confirmation this week, and the warning by Republicans that they will change the rules of Congress to vote him in anyway. While it is not seen as market moving, it is another look at the lack of cooperation in Congress.
"The political capital that needs to be expended to get the noneconomic changes through, the less momentum and support Trump will ultimately have for his market-friendly initiatives," said Lyngen.
The next big political showdown could come around the April 28 deadline for Congress to pass a budget to keep the government from shutting down.
"Watching how the continuing resolution at the end of the month is resolved will be constructive in terms of how Republicans and Democrats are able to get along," said Mark Cabana, Bank of America Merrill Lynch's head of U.S. short-rate strategy.
"Both parties have an incentive to try to get that resolved in a timely way. The Congress is only in session for the rest of this week, and then a few days in late April. Something needs to happen quickly on that, and depending on how easy that is, it could signal how they will work on other results," Cabana said.
Treasury yields have been coming down since mid-March, even as stocks have held onto most gains. The widely watched benchmark yield has slid from a high of 2.629 percent to just above 2.30 percent early Tuesday. It was at 2.35 percent in midday trading, after dipping to 2.31 percent earlier Tuesday. The meanwhile is just 2 percent below its all-time high.
Strategists said bonds were overbought, and yields broke a downtrend Tuesday morning, as President Trump met at the White House with CEOs to discuss deregulation, infrastructure and other topics.
Strategists say it's possible the yield could break below 2 percent again, if there is no new strength in economic data or some form of cooperation among lawmakers emerges. The latter could drive it back toward 2.5 percent.
The curve is also "flattening," meaning the spread between the shorter-duration two-year and the longer-duration 10-year is getting narrower. That is sometimes an indication of a weakening economy or an overly aggressive Fed, but strategists say the central bank's rate hiking regime is not seen as overly aggressive right now.
"We think ultimately there will be some sort of fiscal stimulus delivered," said Cabana. He said there could be an effort to merge legislation on taxes with fiscal spending in order to get more Democratic support. "I think they really need a win, and that is probably the cleanest way to do that," he said.
Lyngen said he is also watching Trump's meeting with the Chinese president later this week.
"The episode could leave the market with broader concerns about the U.S.-China relationship, so he has a fine line to walk between pushing forward his political agenda and being diplomatic. The risks are skewed towards more political uncertainty than any clear direction on the China-U.S. relationship," said Lyngen.
Watch: Why everyone got bonds wrong
Correction: This story has been revised to reflect the correct name of PGIM.