Trump Tax Plan

The first draft of the Trump Tax Plan was revealed on Wednesday. The relative level of detail compared with previous policy attempts by the Trump team indicate that House and Senate Republicans have been consulted and that the probability of success is higher than past policies. Some areas remain vague, probably opening the door for negotiation. That past attempts at policy such as the repeal of Obamacare, the travel ban and the building of a Mexican wall, have failed have resulted from negligent outsourcing to Congress on the one hand, and friendly fire from Republicans.

The tax plan is particularly generous to corporates, cutting taxes from 35% to 20%, but taxes overseas profits and imposes a one-time repatriation tax to attract the estimated 2.6 trillion USD of accumulated profits abroad. An important policy point will be the deductibility of interest expense which has yet to be quantified and will certainly be negotiated. On the personal income tax front, a simplification of the tax code appears to be a broad tax cut but the loss of deductibles will likely be revenue neutral. The aggregate impact will, however, not be revenue neutral and is expected to add 1.5 trillion USD to the national debt over the next decade. This will be a point of contention.

The impact of the tax plan is clearly a policy of fiscal expansion which will boost growth, inflation and market determined interest rates.

The Fed may be forced to react to increased inflation expectations leading to more aggressive rate hikes and balance sheet normalization.

The immediate impact of a tax cut on corporate earnings will be a one-time boost to FY2018 earnings, of circa 10%. The longer term impact is also positive for demand. Financing costs will, however, rise.

On balance:

  • A stronger USD.
  • Weaker US treasuries.
  • Good for companies with a high tax rate, less advantageous for those who already face a low tax rate.
  • Good for capital intensive companies. Less advantageous for less capital intensive ones.
  • Encourages companies to call or buy back bonds, not shares. Creates potential undersupply of debt instruments.
  • Personal tax code gets more regressive increasing savings rates and exacerbating demand for yield assets.
  • A strong USD is negative for equity markets in countries with high interest rates and positive for equity markets in countries with low interest rates.
  • Rising interest rates will increase demand for floating rate debt instruments, sometimes beyond fair value.

We caveat the above outlook on the reality that the tax deal will certainly be subject to negotiation and debate and will not be accepted in its entirety.

China Eases Liquidity

The PBOC announced a cut to the RRR of between 0.5% to 1.5% subject to conditions. The measures are aimed at boosting growth in the SME sector even as the PBOC reins in credit in overheated areas such as real estate and construction.