If Trump tax package increases the deficit, will Powell offset it?

Week ending Friday December 1st 2017

Dominating U.S. markets this week was the improved prospects for Trump-sponsored tax cuts. Equities loved the idea of corporate tax cuts even if the benefits ultimately are passed on to the consumer – especially for those corporates that pay corporate taxes. Mostly this is U.S. domestic-focused banks and small/mid-sized companies. Big tech, oil and pharma have many and clever ways to avoid corporate tax thanks to large overseas operations.

One thing at a time

That said, the tax package is not yet passed in Congress. Until the package is passed and is read by markets, it is hard to for anyone to consider the macroeconomic impact. For monetary policy, the seeming lack of matching spending cuts means any fiscal stimulus should be offset by tighter monetary policy. However, as we said last week, and will keep saying, quite how the Powell Fed will react is still very hard to fathom – markets are still giving modestly excited signals.

Equities have responded well. The USD has remained near its 2017 lows. TIPs have rallied but longer bond yields are still tightly range-bound, even if they did tick up on the tax package progress. Short-term yields, however, also rose, implying the market thinks the Fed would tighten to offset any fiscal stimulus. The 10yr-2yr spread thus hardly moved all week – but at a higher level of rates across the curve, a bullish sign. To be strongly bullish we would need to see a considerably steeper yield curve, led higher by longer bond yields.

News

A string of good news from multiple data sources certainly underpinned rising equities and bonds. Strong New Home Sales and better Personal Income data for October, Richmond and Dallas Fed surveys and Conference Board Consumer Confidence for November were matched by 5%+ QoQ (annualized) NGDI growth announced with the 2nd estimate of GDP for 2017Q3. Actual 2017Q4 growth indications look like another good quarter following on the momentum of Q3. The RGDP nowcasts are very bullish, with the Atlanta Fed at 3.5% and the NY Fed at 4.0%

NGDP Levels remain poor and trends still way off target, assuming the goalposts have been moved. It presents quite a challenge to Powell should he get confirmed. Will he look at anaemic inflation figures or worry, like Yellen, about Phillips Curve phantoms around every corner? We just do not know. He seems to be playing things straight at the moment, loyally supporting Yellen and the Board of Governors.

Next week there are more November surveys but also the delayed November payrolls to give us concrete numbers of employment and income, Dominating the news will be tax packages and (the usual) political intrigue.

During the week we will also see more and more talk about the December 13th FOMC meeting where markets are 97% certain rates will be raised 25bps for the third time this year. Future moves will be closely watched as expecations for another rise in March 2018 have moved to over 50%.

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