President Donald Trump may face the sternest test of his ambitious economic policies to date this week as the Treasury prepares to raise more than $250 billion in a series of bond auctions spread over three days that will gauge investor appetite for U.S. debt amid rising yields and a ballooning federal deficit.
Fresh off a Republican-led tax cut that will add an estimated $1.5 trillion to the country's debt pile over the next ten years, and a recently-agreed budget plan that will pump the deficit by $300 billion, investors are starting to question the President's strategy of priming the world's biggest economy with stimulus at such a late stage in the business cycle with a trillion dollar infrastructure plan. The Atlanta Federal Reserve's GDPNow forecast suggests a first quarter growth rate of around 3.2%, inflation sits at just over 2% and the country's jobless rate have been hovering at a 17-year of 4.1% for the past three months.
"The big surprise many noted last week was the fresh highs in US yields failing to derail the ongoing equity market recovery," said Saxo Bank strategist John Hardy. "On the currency side, the narrative is that the US dollar can continue to fall as US interest rates rise because the rise in US yields reflects concerns on the US fiscal/current account balance sheet more than it reflects a strengthening US economy."
Benchmark 10-year U.S. Treasury bond yields hit a four-year high of 2.944% last week amid the global equity market rebound and the best five-day gain for the S&P 500 since 2011. The moves, which mirrored continued weakness in the dollar as it fell to a three-year low against a basket of its major global peers, have puzzled analysts who have wondered what signals they're sending with respect to broader confidence in Trump's handling of the economy.
"For the US dollar to re-couple with rising US bond yields, we'd need to see a return in (relative) confidence over the medium-term US economic outlook," said ING analysts in a client note. "Broadly, we're scratching our heads at finding any new positive US demand or supply shocks that could change the landscape for an economy in the 10th year of its expansion cycle. Without this, it's easy to see the weak dollar story persist."
A big measure of investor willingness to take down the quarter trillion in debt on offer will be be the market's ability to hold 10-year yields under 3%, a figure that many analysts have suggested could start the flow of cash from equity funds into fixed income portfolios. While no 10-year notes are on offer this week, $92 billion in 2-year, 5-year and 7-year notes will be auctioned on Wednesday and Thursday after more than $151 billion in short-term Treasury bills are placed in the market on Tuesday.
Goldman Sachs expects Trump's myriad stimulus policies to have diminishing returns on economic growth over the next two years, but noted that they'll likely expand the U.S. Federal deficit to 5.2% of GDP by 2019. However, while arguing that "further expansion would put the U.S. onto an even less sustainable long-term trend", Goldman also noted that the one-time nature of the tax cuts and the potential for a change in control of the House after this year's mid-term elections will probably keep a long-term lid of deficit expansion in the medium term.
This, it could be argued, could further cement the near-term case for U.S. stocks, even as the total return generated by the S&P 500 slowed to 5.7% in January, around half of its 10.1% annual average of the past 50 years.
With around two thirds of the S&P 500 reporting so far this season, Thomson Lipper expects fourth quarter earnings to grow 15% from the same period in 2016, compared to a 14.6% expansion rate for the Stoxx Europe 600, while its first quarter expectations are for a growth rate of 18%. Furthermore, the market's recent correction, which hived more than 10% from both the S&P 500 and the Dow Jones Industrial Average, has trimmed the forward PE ratio for U.S. equities to around 17.2.
Still, as Saxo's Hardy notes, "it is hard to believe, last week's action notwithstanding, that a persistent rise above (3% on 10-year bod yields) would be met with a shoulder shrug by asset markets, from equities to (emerging markets)."
It should be a fascinating week.