Despite the ‘de-escalation’ with China, there are still calls for the Fed to take its cues from the slightly softer wage and inflation data, to cut a couple of times this year. In doing so, they would risk a further selloff in the long end of the curve. It is telling that long bonds have been unable to find a bid. With the US economy at full employment, core inflation still stuck above target, and a major fiscal boost incoming, the Fed should keep rates on hold, at the very least.
Overall, the data remain solid. Corporate profits are at record highs as a share of GDP. The rise in real disposable personal incomes suggest consumption could firm again in Q2. Aggregate delinquency rates remain low. Households have deleveraged significantly, and debt service ratios have barely shown much of an increase. This could support the stock market rally over the coming months.
But with the federal budget deficit still tracking at around $2tr, all eyes are turning to the impending tax cuts set to be passed by Congress. Even if Republicans’ tax cutting ambitions are scaled back somewhat, the final bill is still set to add trillions to the deficit over the coming years, threatening to push up bond yields further, which could eventually weigh on equities.
Whether the bond market forces a U-turn on fiscal policy before the passage of the tax bill, or afterwards, remains to be seen. But repeated claims of fiscal responsibility will soon be put to the test by the bond market.
