Tax Plan To Be Worked Out This Week
Last Thursday the Senate released its plan to cut taxes which sent the market falling because the tax cuts start in 2019. The Senate’s amendment process starts on Monday. That’s when the details will be hashed out. We will probably see the market move on headlines regarding the debate. It’s the main event hanging over the market given the fact that the economy is thought to be stable, earnings season is largely over, and President Trump picked Powell as Fed chair. The House Ways and Means Committee put out its version of the tax plan on Thursday. There will be a vote on that plan next week. As you can see, the House is ahead of the Senate. Afterward both chambers pass a plan, the differences between each plan will need to be reconciled.
The chart below reviews the differences between the two plans. As you can see, the Senate plan keeps the same number of tax brackets. That seems to go against the idea of simplifying the tax code. We’re very far from the campaign promise of being able to fill out your taxes on the back of a postcard. Many will see a tax increase because of the elimination of the state and local tax deductions. The House plan will add $1.7 trillion to the national debt, meaning the promise to not increase the debt will also be broken. If conservatives decide this plan increases the debt too much, it will be dead on arrival. Because the Senate plan gets rid of all the state and local tax deductions and the House plan lets taxpayers deduct up to $10,000 in property taxes, I think the Senate plan will end up raising the debt less. The maximum increase under the reconciliation rules is $1.5 trillion.
ECB Tapering
As I discussed in a previous article, the reinvestment of the maturing bonds will counteract the ECB’s tapering in 2018. I didn’t explain it as well as I should have. The reinvestments are large because the balance sheet has expanded rapidly in the past few years. While the new bond buying will fall from 60 billion euros per month to 30 billion euros per month, Goldman expects the reinvestments to be 10 billion euros per month. That means the tapering is much softer than initially reported.
The chart on the left shows the two possibilities of tapering which are across the board and proportional tapering. The chart on the right is the size of the bonds needed to be reinvested and the break down of which countries they are from. The reinvestments explode higher in 2018 and 2019. As you can see, there’s going to be about 80 billion euros in reinvestments more in 2018 than 2017, diminishing the role of tapering. The reinvestments jump to above 200 billion euros in 2019. That’s almost 20 billion euros per month. At that point, the purchasing of new bonds will be over, but the reinvestment program will loom over its end.
If the ECB were to start unwinding the balance sheet in 2019 or 2020, it wouldn’t be able to let all of the bonds mature. It would be a slow unwind like the Fed is doing. As I have said before, I don’t expect that to be an option as economic uncertainty always seems to spring up. There is high political uncertainty in Spain with the Catalonian independence movement. Something like that could spark the need for more QE if it effects the economy, which it could. I don’t even think the Fed will get done with its unwind before the next recession as that will take a few more years. The effectiveness of these policies will be questioned especially with the ECB running out of bonds to buy. There doesn’t seem to be a plan to deal with this as most mainstream economists predict green pastures for as far as the eye can see.
Economy Strong
As I discussed when mentioning the optimism of the Chinese consumers in my last article, the American consumers are expressing high levels of positivity. The weekly consumer comfort index fell slightly from 51.7 to 51.5. The view of the economy improved slightly from 51.8 to 51.9. The personal finances index fell from a 5 month high of 60.6 to 59.3. That’s probably representative of the fact that interest rates are so low that the amount of debt taken out isn’t a problem in the near term. That’s the only way to justify the over $1 trillion in consumer debt. The buying climate index increased from 42.6 to 43.3. That’s great news as the holiday shopping season starts in less that 2 weeks. The sentiment from people with a high school diploma was 50.2 which is the highest reading since February 2007. The confidence rose for renters, part time workers, and people in the West. The first two show how the strong labor market and moderation of rent inflation are helping confidence.
The GDP Now report is showing expectation for 3.3% GDP growth in Q4. That’s above the blue chip consensus which is 2.7%. The blue chip is right where it was at last quarter. I am looking forward to the end of the month when we get the first revision on Q3 GDP which looked strong in the advanced reading although it was boosted by inventory growth. The St. Louis Fed, which was almost exactly right about the Q3 advanced reading, expects 2.95% growth in Q4. The NY Fed GDP forecast was updated Friday to show 3.15% growth. As you can see, they are all bunched together. The holiday shopping season will have a big impact on how good the quarter will be.
Conclusion
The biggest economic report investors will be focused on for the next few quarters is inflation. If inflation increases modestly, there’s not much for stocks to worry about. The biggest story for the rest of the year will be tax reform. The biggest movements in stocks will likely come in the lead up to the legislation. Although if a vote comes out and it’s unexpectedly struck down, it could cause volatility in stocks.
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