US interest rates continued to fall last week as the Republican Congress failed to move forward on replacing and reforming the Affordable Care Act (ACA). US 10-year yields fell to 2.39% and US equities were off 1%. The US Dollar also declined versus the Euro (now 1.09) and the Yen (now 110.15). The tight range we have had in US yields so far in 2017 has held. After reaching 2.60% on March 15th when the Federal Open Market Committee (FOMC) hiked the funds rate and 10-year yields have now fallen more than 20 bps. Spreads for fixed income risk assets have been further pressured with negative excess returns: March month-to-date for US high yield is 106 bps, US corporate investment grade 20 bps, and US MBS -5 bps.
Rather than risk losing the health care reform and repeal vote on Friday, the House Republican leadership in coordination with the White House canceled the vote. Despite the Trump administration’s efforts to strong arm his party. The 35 or so members of the conservative House Freedom Caucus were not convinced and with no support from the Democrats the measure simply did not have the votes. The failure to pass an ACA reform deals a serious blow to the credibility of the Republican Congress and to the Trump presidency. The infighting in the Republican Party calls into question their ability to govern effectively. The key question for markets is whether or not other market friendly priorities including tax reform, fiscal stimulus, military, and infrastructure spending are now also at risk?
As the week went on and the reform and repeal vote seemed less and less likely to pass, risk assets underperformed. Markets seem to have a growing uncertainty over the Trump reflation trade idea. Is the defeat of ACA reform a harbinger of future failures on Trump’s pro-growth agenda? Should markets assign lower probabilities to tax reform and fiscal stimulus? Should we lower our expectations for the anticipated size of tax cuts and infrastructure spending? The Trump administration desperately needs a near term victory. And it would seem that the Republicans need to make quick and steady progress on tax reform in order to further sustain the post-election rally in stock prices and the tightening of credit spreads.
In other economic news, this week we had several reports on the US housing market. For only the second time since the global financial crisis the Federal Housing Finance Agency (FHFA) reported a flat month-on-month change in the Home Price Index. However, the year-on-year change in the Home Price Index was a healthy 5.7%. Mortgage origination rates moved sharply higher after the November election, and market participants are trying to gage the impact these higher rates are having on housing activity.
February existing home sales, reported last week, fell 3.7% versus the strong January report which had been the highest level in the series in 10 years. Conversely, sales on new homes rose 6.1% over January and have started the year on an upward trend. The warmer winter weather may have helped January and February sales, but it does not appear that the rise in mortgage rates is having a meaningful impact on housing activity.
One other important factor impacting existing homes sales and supporting home prices is scarce housing inventories. In many areas of the country a limited supply of homes for sale is driving home prices higher. At the same time, demand for homes is increasing due to improved job markets and growing consumer confidence. Our chart of the week shows the US Existing Home Sales Months of Supply near historic lows. The impact of the rate rise bears watching, but so far it is not having a material effect on housing activity.Download to read more