The non-agency RMBS market paused slightly on the Republican’s tax reform package. Among other changes, the proposal would reduce the cap on principal for a mortgage interest deduction (MID) from 1 million USD to 500K USD, and would increase the standard deduction from 12,700 USD to 24,000 USD per family. Analysis by the Cleveland Federal Reserve expects that full elimination of the MID could reduce property prices in Washington, DC by 13.5% and in Miami by 3.5%, the differences reflecting different rates of utilization of the MID. The changes to deduction rules would tend to reduce homeowners’ incentives to take out large home loans, and thus could lead to a lower supply of mortgages, an incremental positive for MBS, rather than a negative. Nevertheless, the market has taken a pause to digest the potential development. It is unlikely, in our view, that the proposal will pass in its entirety, given the broad impact on the housing market. We remain bullish US RMBS across non agencies and agency CRTs.

The subordinated financials market has done very well in the past month. The ECB has signalled a tougher approach to the recognition and treatment of NPLs which is likely to encourage further deleveraging and to divert cash flows from equity dividends towards sub debt coupons. We are upgrading our outlook on European sub financials.

Last week the BoJ met and indicated no change to policy, as we expected. The BoJ will likely be less hawkish than any other major central bank given the condition of state finances. We see Japan as an emerging growth area with attractive equity opportunities but at the same time see the BoJ unable to substantially reduce monetary accommodation. That means weak JPY and strong equities.

Last week the Fed met and indicated no change to policy. It did upgrade its growth assessment. The Fed has been proved correct in its assessment that the moderation in growth earlier in the year has been transitory. We see a rate hike in December and three more in 2018 as the Fed keeps its word. The market is pricing in only a less than 30% chance that all three rate hikes will get done in 2018. This implies potential for further USD strength and higher bond yields. Maintain a short duration stance.