After flattening yesterday, following hawkish commentary by Fed officials (which have pushed the probability of a March Fed Funds Rate hike to over 80%, according to Bloomberg), the curve steepened this morning, due mainly to President Trump’s comments and policy plans. What did Mr. Trump say that was different? Not much, really. Other than proposing merit-based immigration policies (where the skills of immigrants would be a prime decision making factor), the policy rhetoric was much of the same. The difference was that the President spoke in a calm and cogent manner.
However, depending one’s political ideology, the speech was either a brilliant unqualified success or something out of the “Malleus Maleficarum.” I will try to paint an agnostic opinion based on economic theory.
Honestly, it is the message that matters and not the messenger. It could have been Donald Trump, Hillary Clinton or the Dali Lama presenting the policies discussed in last night’s speech and it would not have mattered one bit. What I heard last night was:
- Taxes will be cut (no clear plan).
- Capital will be repatriated (no clear plan).
- Infrastructure will be rebuilt or replaced (no clear plan).
- Production will be on-shored (no clear plan).
- Business Regulations will be eased (some clarity).
- Healthcare Reform (modest clarity)
- Immigration policies will be reformed (clarity in the way of a wall with Mexico and merit based immigration).
The first question which is probably going through the minds of readers is: Which policies do I like? Let me be clear, it does not matter one bit what I like or don’t like. To formulate strategy, we must attempt to anticipate what policies might be suggested, what their final form might look like and how much opposition might policies experience (the greater the opposition the less likely policies are to be implemented or modified from their proposed forms). The way I see it is:
Mr. Trump will probably get most, if not all, of his policies through Congress, but in altered form (perhaps radically altered form). Economic theory suggests tax cuts and regulation reform could/should increase productivity. Healthcare reform could add to productivity gains. Merit based immigration could help population growth (which is expected to otherwise become flat, in the prime working-age demographic, by 2030). Based on these policies, the economy could be well on the way to 3.0% annual GDP. However, proposals which require the on-shoring of production, trade tariffs and the possibility of requiring repatriated capital be used for hiring and wage gains, could partially offset the benefits from lower regulations and lower taxes. In my view, this adds up to somewhere between 50 and 70 basis points added to the structural potential of annual U.S. GDP.
This is not to denigrate the President or minimize the benefits of tax and regulatory reform, but unless one is a political zealot, one must look at all economic policies. What about infrastructure spending? I see this creating inflation pressures more than economic growth as such programs rarely turn out as expected. What about a partnership with the private sector? Unless private companies are permitted to share in revenues generated by infrastructure projects, it is unlikely public/private partnerships works as expected. I would point out that, many revenue-generating infrastructure programs and facilities (bridges, mass transit, airports, etc.) often need funding beyond what tolls, fares and fees provide.
Fine, Mr. Trump will probably get most or all of his programs through Congress, but they are unlikely to pass quickly and are unlikely to be unaltered. For example; few GOP members favor building a wall on the border with Mexico. This was evidenced by the smattering of applause from the right side of the aisle’ last night. Mr. Trump has made the wall one of his defining goals. Does he fight an uphill battle to build the wall, delaying the implementation of pro-growth fiscal policies and burning much-needed political capital? Or does Mr. Trump cave on the wall to get tax, healthcare and regulatory reforms through the legislative process? This remains to be seen.
Then there is the border-adjusted tax (BAT). Mr. Trump is not anywhere close to having sufficient GOP support to get the BAT through Congress, if he himself wants it. With only a small GOP majority in the senate, it does not appear likely that a BAT gets through Congress.
What about infrastructure spending? Republicans, particularly the Tea Party wing, bashed former President Obama for increasing the national debt and budget deficit. Many are also pushing back on President Trump’s infrastructure proposal. This is another policy effort which might not get through Congress, at least not without much alteration. (5) (6) (7)
The way I see it is: Fiscal policy reform will probably be a long drawn-out multi-year process. The Trump Administration has chosen to address the Affordable Healthcare Act, first. With no clear replacement in place, millions of people and tens of thousands of businesses, having adjusted their existences around ACA, wholesale changes could be disruptive to the economy. Wholesale changes are unlikely to get through Congress (particularly the Senate), either.
What I think we see is Trumponomics-lite:
- Banking regulations lightened, a little, but large banks will still have to hold elevated levels of reserve capital.
- ACA will be tweaked, but will largely resemble what is already in place.
- Individual income tax policy will probably be simplified (with perhaps just three tax brackets), but deductions will probably be curtailed, mainly at the top bracket.
- The stated corporate tax rate is probably lowered to 20% from, 35%, but when fewer deductions and the fact that the effective corporate tax rate is close to 25%, at the present time, benefits should be real, but muted.
- I do not see the BAT or protective tariffs getting through Congress, not as stated, if at all. The wall is probably a non-starter and merit-based immigration policies could experience push-back by GOP centrists for being too restrictive and far right members for being too liberal.
- The Tea Party is going to put up a fight over debt-fueled infrastructure spending. Since not every infrastructure project is revenue-generating, I expect only limited private sector participation. As a result, I foresee infrastructure-lite, with a moderate boost to inflation pressure, but only a modest boost to GDP growth.
Again, the way I see it, the best we should expect is an additional 50 to 75 basis points of GDP growth, if Mr. Trump does not waste political capital on social policies. Even this might be somewhat optimistic, given demographics, the ability of foreign governments to retaliate and the ability of many foreign companies (many of which have very wide profit margins) to simply eat import taxes and tariffs, to maintain market share. Of course, if Mr. Trump can continue to tone down his rhetoric, he probably has a better chance of getting (mostly) what he wants versus pounding businesses and foes, as he has done, since Election Day.
About Thomas Byrne
Thomas Byrne brings nearly 30 years of financial services experience to Wealth Strategies & Management LLC. He served as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.