The markets' post-election reactions -- higher stocks, Treasury yields and dollar -- have been based in part on expectations of pro-growth policies under the Trump administration. The boost to the economy may be smaller and take longer to occur than the markets now expect, however, providing a fundamental reason for the corrections -- lower stocks, Treasury yields and dollar -- that technicians say are coming. Nonetheless, the extent and timing of the policies may not get full market attention until we get closer to the January 20th start of his administration.
Trump's proposal for cutting individual taxes is an example. He wants to cut tax rates and eliminate the ObamaCare 3.8% surtax on capital gains/dividends and investment income as well as the Alternative Minimum Tax and most of the Estate Tax.
Timing
1. It should take a number of months before tax legislation gets through Congress.
a. There could be changes to Trump's proposal, particularly since it differs somewhat from the Republican Congressional tax plan and runs counter to Republicans' desire to cut the Federal deficit. Hearings and debate could delay implementation.
2. The lower tax rates -- particularly at the upper end -- could
spur more risk taking and work effort. This supply effect would likely
take time to develop.
3. The other parts of his plan would not show up until final tax payments are made in 2018.
Magnitude of Impact
1. The lower tax rates would boost disposable income quickly. But, with much of the reduction at the upper income levels, a good share of the freed-up income will likely be saved rather than spent -- reducing the boost to economic activity. However, the elimination of the Estate Tax for most everyone could lift spending by those who were saving to meet a "bequest" goal.
a. Democrats are likely to complain about the
distributional aspects of his proposal. Ideas to make the tax code more
progressive could be
counter-productive if they discourage economic activity -- which would hurt lower-income people.
2. Part of the spending would be on imports, also reducing the boost to US economic activity.
3. But, a small boost to consumption is not
undesirable at this time, given that the economy is close to
full employment and growing near trend.
4. Given the likely limited near-term boost to the economy and the absence of a need to do so, the Trump proposal's main rationale may be the longer-term incentive for risk taking and work effort. But, the magnitude of this impact is anybody's guess.
Monday, December 26, 2016
Thursday, December 8, 2016
Stock Rally Likely To Continue Past Next Week's FOMC Meeting
There are several reasons why the stock market rally will likely continue after the widely expected 25 BP Fed rate hike next Wednesday (December 14). In broad terms, they are /1/ a strong economy, /2/ a Fed emphasis of a gradual further tightening in 2017, and /3/ expectations of Trump's fiscal and economic policies. These reasons should propel the rally at least into January. They also should keep upward pressure on Treasury yields and the dollar, but -- thanks to low inflation -- the upward pressure may be modest.
1. Strong Economy:
a. Both the NY Fed and Atlanta Fed's models are now projecting about 2.5% (q/q, saar) for Q416. While moderate from an historical perspective, this pace is above trend. It is also stronger than the 0.9% Real GDP Growth Rate in Q415 when the Fed last tightened by 25 BPs.
b. Initial Claims have averaged 255k so far in Q416, slightly lower (and thus stronger) than the 259k Q316 average. Continuing Claims have been on a downtrend since September, after stalling from April through August.
c. The ECRI Leading Index has risen sharply in the past few weeks, suggesting a further pickup in GDP Growth into Q117.
ECRI Leading Index (level, July Through November)
2. Gradual Fed Tightening in 2017:
a. NY Fed President Dudley said this week that he favored a gradual approach to tightening.
b. Uncertainty about the scope of fiscal policy changes should keep the Fed cautious until there is more certitude. This will likely happen by next Spring or Summer. So, the Fed should fade from the markets' forefront in early 2017.
c. The Fed is likely to emphasize a gradual approach in the Statement and in Yellen's post-meeting press conference, the same as it has done in the recent past.
d. But, there could be some narrowing in the 2017 range of "dots" from September's 1.1-1.8% range. An upward adjustment in the lower bound of this range is the most likely change, but the consensus expectation of 2-3 more hikes in 2017 should remain intact.
3. Trump's Policies:
a. There are 3 main issues: /1/ the magnitude of the tax cut, /2/ the extent and speed of deregulation, and /3/ the approach taken on foreign trade.
b. The Republican dislike of large Federal Budget Deficits could limit the size of the tax cut. In Congressional testimony earlier this month, Yellen cautioned about overdoing fiscal stimulus now that the economy is close to full employment. But, she did not mention that it would fit with her idea of running a hot economy to stimulate stronger productivity gains.
c. The Trump Administration's presumably pro-business/less regulatory approach should be a factor preventing the sharp slowdown in GDP Growth seen after the December 2015 Fed rate hike. Obama's renewed shift to executive orders in Q415 likely was partly responsible for the slowdown.
c. A move toward bi-lateral trade agreements in order to push other countries to eliminate tariffs would be a positive for the US economy and the dollar. A trade war, however, would be bad. I wonder whether Trump's telephone call to the Taiwanese president was part of a strategy to "soften up" the Chinese government ahead of such trade negotiations.
1. Strong Economy:
a. Both the NY Fed and Atlanta Fed's models are now projecting about 2.5% (q/q, saar) for Q416. While moderate from an historical perspective, this pace is above trend. It is also stronger than the 0.9% Real GDP Growth Rate in Q415 when the Fed last tightened by 25 BPs.
b. Initial Claims have averaged 255k so far in Q416, slightly lower (and thus stronger) than the 259k Q316 average. Continuing Claims have been on a downtrend since September, after stalling from April through August.
c. The ECRI Leading Index has risen sharply in the past few weeks, suggesting a further pickup in GDP Growth into Q117.
ECRI Leading Index (level, July Through November)
2. Gradual Fed Tightening in 2017:
a. NY Fed President Dudley said this week that he favored a gradual approach to tightening.
b. Uncertainty about the scope of fiscal policy changes should keep the Fed cautious until there is more certitude. This will likely happen by next Spring or Summer. So, the Fed should fade from the markets' forefront in early 2017.
c. The Fed is likely to emphasize a gradual approach in the Statement and in Yellen's post-meeting press conference, the same as it has done in the recent past.
d. But, there could be some narrowing in the 2017 range of "dots" from September's 1.1-1.8% range. An upward adjustment in the lower bound of this range is the most likely change, but the consensus expectation of 2-3 more hikes in 2017 should remain intact.
3. Trump's Policies:
a. There are 3 main issues: /1/ the magnitude of the tax cut, /2/ the extent and speed of deregulation, and /3/ the approach taken on foreign trade.
b. The Republican dislike of large Federal Budget Deficits could limit the size of the tax cut. In Congressional testimony earlier this month, Yellen cautioned about overdoing fiscal stimulus now that the economy is close to full employment. But, she did not mention that it would fit with her idea of running a hot economy to stimulate stronger productivity gains.
c. The Trump Administration's presumably pro-business/less regulatory approach should be a factor preventing the sharp slowdown in GDP Growth seen after the December 2015 Fed rate hike. Obama's renewed shift to executive orders in Q415 likely was partly responsible for the slowdown.
c. A move toward bi-lateral trade agreements in order to push other countries to eliminate tariffs would be a positive for the US economy and the dollar. A trade war, however, would be bad. I wonder whether Trump's telephone call to the Taiwanese president was part of a strategy to "soften up" the Chinese government ahead of such trade negotiations.
Friday, December 2, 2016
November Employment Report Should Not Stop a December Fed Hike, But...
The November Employment Report should not stop Fed officials from tightening by 25 BPs in December, but should reinforce their desire to emphasize a gradual approach to next year's tightening. Such a combination at the December FOMC Meeting should be a positive for stocks and possibly for Treasury prices, but a negative for the dollar.
The bottom line of the Report is that the US economy is growing at or above trend, albeit likely only in the moderate 2.0-3.0% (q/q saar) range, in Q416. Both the strong and weak parts of the Report appear to be exaggerated by technical or temporary factors.
1. The +178k m/m increase in November Payrolls was boosted by a 22k jump in Government Workers. Most of the latter jump was outside of education and likely consisted of temporary election workers. These should reverse in December.
2. Private Payrolls -- more indicative of the economy than are Total Payrolls -- rose only 156k after they rose only 135k in October. Both are below the 170k 12-month average ending in November. So, they suggest a downshift in the underlying trend of job growth.
3. Even with this downshift, job growth is enough to put the Unemployment Rate on a downward path -- as evidenced by the drop in the Unemployment Rate to 4.6%.
a. The drop could be lagged effect of the strong 3.2% Q316 Real GDP Growth. The traditional model relating the Unemployment Rate to GDP Growth shows both the current quarter's and past quarter's GDP Growth impact the current quarter's change in the Unemployment Rate.
b. While Street Economists may emphasize that the drop in the Unemployment Rate to 4.6% in November was "due" to a decline in the Labor Force, it is more likely that the composition of the Rate -- Labor Force and Civilian Employment -- was influenced by the small sample nature of the Household Sample. The Sample just happened to consist of people who fell out of the labor force. The Unemployment Rate, itself, cancels out this small sample bias, so its decline
4. The low -0.1% m/m Average Hourly Earnings was likely largely a result of calendar factors and thus exaggerates weakness.
a. These factors point to a 0.3% m/m increase in December.
b. The y/y fell to 2.5% from 2.8% in October. But, it remained in the 2.5-2.8% range seen since May. If the m/m rebounds to 0.3% in December, the y/y will bounce back to 2.8-2.9%.
The bottom line of the Report is that the US economy is growing at or above trend, albeit likely only in the moderate 2.0-3.0% (q/q saar) range, in Q416. Both the strong and weak parts of the Report appear to be exaggerated by technical or temporary factors.
1. The +178k m/m increase in November Payrolls was boosted by a 22k jump in Government Workers. Most of the latter jump was outside of education and likely consisted of temporary election workers. These should reverse in December.
2. Private Payrolls -- more indicative of the economy than are Total Payrolls -- rose only 156k after they rose only 135k in October. Both are below the 170k 12-month average ending in November. So, they suggest a downshift in the underlying trend of job growth.
3. Even with this downshift, job growth is enough to put the Unemployment Rate on a downward path -- as evidenced by the drop in the Unemployment Rate to 4.6%.
a. The drop could be lagged effect of the strong 3.2% Q316 Real GDP Growth. The traditional model relating the Unemployment Rate to GDP Growth shows both the current quarter's and past quarter's GDP Growth impact the current quarter's change in the Unemployment Rate.
b. While Street Economists may emphasize that the drop in the Unemployment Rate to 4.6% in November was "due" to a decline in the Labor Force, it is more likely that the composition of the Rate -- Labor Force and Civilian Employment -- was influenced by the small sample nature of the Household Sample. The Sample just happened to consist of people who fell out of the labor force. The Unemployment Rate, itself, cancels out this small sample bias, so its decline
4. The low -0.1% m/m Average Hourly Earnings was likely largely a result of calendar factors and thus exaggerates weakness.
a. These factors point to a 0.3% m/m increase in December.
b. The y/y fell to 2.5% from 2.8% in October. But, it remained in the 2.5-2.8% range seen since May. If the m/m rebounds to 0.3% in December, the y/y will bounce back to 2.8-2.9%.
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