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Thursday, April 27, 2017

FX, Bond and Commodity Traders Simply Do Not Believe Tax Reform Will Deliver The Promised 4-5% Growth.

We get some useful data, including durables, wholesale inventories and initial jobless claims, but attention will be on the ECB policy meeting The ECB is expected to sit on its hands and Mr. Draghi to deny any change is being planned. He will likely say economic growth is steadying but inflation is not at such a sustainable level that it warrants a policy change. We get the April flash CPI tomorrow but the big ECB economics re-boot in June is probably the first time we can reasonable hope for a shift in forward guidance. Besides, the ECB must wait until after the next round of French presidential elections. Hope runs high the voters reject the only woman in France with no sense of style.

We will all be watching the press conference today anyway because it’s a relief to watch a competent and charming guy take the stage after our inept boor. Still, Draghi will be discretion itself. That redirects attention back to the freak show in the US.

One of the most interesting developments in a long time is the disparate response of different markets to the tax reform proposal. Equities mostly liked it, although the US equity indices closed down on the day. Companies will be busily figuring out how to game the new system. After all, the true effective tax rate is already more like 20% once the green eyeshade boys get to work.

But the 10-year yield was flat, closing at 2.311% (and down from a higher high) from 2.327% the day before. We call that a yawn. Oil was floppy and gold actually rose. Commodities in general remain gloomy. This may mean that the monetary policy side, still somewhat in question, has more juice than the fiscal side. It also implies that FX, bond and commodity traders simply do not believe that tax reform will deliver the promised 4-5% growth. The US is a mature economy and can’t be expected to deliver emerging market/frontier market growth rates. The headline could read “Fed beats Trump.” The Fed does not see wild growth or the inflation wild growth would imply. And on that theme, yesterday the CME reported Fed funds futures show a 67.6% probability of a June hike—down from 71.3% the day before.

We knew the tax reform announcement was due on Wednesday and we knew most of the features, but the event was still reported as though it were shocking fresh news. Maybe because the press conference was a joint effort by TreasSec Mnuchin and Gary Cohn, National Economic Council director. Here are just some of the issues:

• The announcement was on a single sheet of paper. The US tax codes runs to tens of thousands of pages. It’s a travesty to call what we got a “plan.” Any idea that these few ideas can be converted, technically, into a plan anytime soon is ridiculous. And any idea that it can be passed, even with Congress in the same party as the president, is even sillier. Example: the Trump initiative removes the state and local tax deduction from the federal bill. The states with the highest taxes are New York , New Jersey and California, which did not vote for Trump. These are also the states with the biggest populations.

• Mnuchin made it clear that we will never, ever get Trunp’s tax returns and therefore whatever benefit he gets from the new tax regime—and it absolutely favors the rich—will be substantial. The Committee for a Responsible Federal Budget estimates the plan will cost $3-10 trillion in lost revenue over ten years.

• Mnuchin asserts the same tired old supply-side theory that tax cuts will be stimulative and new growth will make up for revenue lost. It has never worked before. The FT suggests that the Joint Committee on Taxation, whose judgment matters, will not accept the idea of “a big revenue fillip from higher growth.”

The WSJ has a dandy chart showing that the US would move from the French level of taxation to somewhere between Ireland and Germany.

We must admit that this is one Trumpian disruption that is welcome, sort of. The problem is not that taxes are too high. The problem is that the tax code is wildly unfair and riddled with loopholes for special interests, very few of whom are average Joe individuals. Unfortunately, we can expect the usual Trumpian carelessness about good management and it’s all too likely we end up with a worse mess and a more unfair one than we have now.

As a sign of mismanagement, consider the NAFTA debacle. Yesterday the White House was talking about pulling out of NAFTA altogether. This was not idle chatter—an executive order was drafted (by Trade Council chief Navarro and “strategist” Bannon). It was almost ready to go to the final stages. But important Plubs, including Arizona’s McCain, came out in force to protest that the consequences would be dire. Trump also spoke to Pena and Trudeau. And voila! Now NAFA will be renegotiated, not repudiated.



There is some possibility this was the intent all along—Wall, dairy, lumber—repudiation! No, just kidding, let’s renegotiate. As a diplomatic style, it stinks. Even as bargaining, it lacks good faith. Trump may think he is coming off as a strong man to be feared, but he’s feared because of incompetence and lakiness. Both the CAD and the peso responded as you would expect. The USD/CAD, on a strong uptrend until then, tanked from 1.3645 to 1.3526 in the two hours after the renegotiation news came out. The dollar/peso, reversed course abruptly, from 19.2304 to 18.9462 in the same two hours. The chart here is in futures format (easier to read at a glance).



Good grief! As everyone was worried about right after the election, Trump is careless and undisciplined about financial matters. These two currencies were already heavily influenced by the NAFTA talk. But what if Trump throws out some irresponsible tweets about the pound, the yen and the euro? We can honestly say that the long-standing factors making for a weaker dollar, chiefly the twin deficits but also disapproval over style and foreign policy, have a new addition—Trump himself.

And we thought Bush Two was a downer. In contrast to Trump, Bush Two looks positively statesmanlike. At least he had the training to avoid reckless talk about currencies and other matter beyond his ken.

Here’s the question of the day—at what point do markets start ignoring noise out of Washington as just that—noise? The press has something to do with it. The FT top headline today is “Trump decides not to withdraw from Nafta.” The top story in the WSJ is “Trump’s Tax Cuts Face Narrow Path Through Congress.” The NYT has “Trump proposes sharply cutting tax rates for individuals.” The Guardian’s top story is about ISIS but underneath, “Trump under fire over ‘huge tax cut for the rich.’” Spiegel Online (in English) has nothing about Trump or taxes or NAFTA on the first page. Maybe that’s the more sensible approach.


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