Well it’s about time.
We were wondering how long it would ultimately be before Jan Hatzius and Alec Phillips got around to commenting on the fact that America’s democracy is coming apart at the seams, but we suppose the delayed reaction makes sense. After all, they probably had to check with all the Goldman employees in Trump’s inner circle to get clearance to write something up.
Over the past couple of days we’ve brought you all kinds of analysis from all corners of the Street (and the world) with regard to the odds of Trump being impeached or otherwise simply abdicating the throne out of sheer exasperation with the whole “separation of powers” and “freedom of the press” thing.
But for those who want to know what’s “really” going on, we present below the latest from
Gary Cohn and Steve Mnuchin Jan Hatzius and Alec Phillips.
Do note that they make the same argument a lot of other folks are making with regard to markets – namely that traders priced out the Trump agenda a long time ago, so if you’re looking for a reason to lighten up on risk, find something besides “Trump.”
The probability that tax legislation will be enacted by 2018 has fallen further, in our view, as a result of recent events. The last few weeks have taken a toll on President Trump’s approval rating as well as support for Republicans in Congress. Exhibit 1 shows the number of seats the president’s party has won or lost in midterm elections back to 1962, compared with the president’s final pre-election approval rating (left panel) and the president’s party’s final pre-election generic ballot poll, which asks voters whether they plan to vote for a Republican or Democrat for Congress in the upcoming election (right panel). Over the last week, the President’s approval rating has averaged around 40%, and Democrats have led generic ballot polls over the last week by an average of 11 points. Both measures are in territory that suggests Democrats could win the House majority if the election were held today, though the smaller number of competitive seats might limit Republican losses. Regardless, as electoral risks grow, potentially vulnerable members of Congress may be less willing to risk supporting controversial legislation.
This could make it more difficult to pass the health care bill and the budget resolution, which need to be addressed before tax legislation can pass. The House-passed health bill is likely to be reworked in the Senate and reaching a compromise between the two bodies will be even more difficult without a strong White House influence. The FY2018 budget resolution, which cannot pass before the health bill is either passed or set aside, will face the same sort of differences between conservative and centrist Republicans as the health legislation. The FY2018 budget resolution is critical since, without it, tax legislation would require 60 votes in the Senate and therefore bipartisan support.
It is also not clear how much support there will be for a simple tax cut. The White House has proposed a tax cut that we expect might cost $3-4 trillion over ten years but House Republican leaders have insisted on revenue-neutral tax reform that does not add to the deficit and earlier this week, Senate Majority Leader Mitch McConnell called for revenue-neutral tax reform as well. While their definition of “revenue-neutral” includes dynamic scoring and other technicalities that might be worth several hundred billion dollars over ten years, even under a loose definition of “revenue neutral” this would seem to preclude a substantial net tax cut.
In light of these developments, we are changing our fiscal policy assumptions. We already assigned a very low probability to comprehensive tax reform by 2018 but recent events make it even less likely in our view. Our base case has been that Congress would enact a reasonably simple corporate and individual tax cut, with incremental reform—limited base broadening and international corporate reform—that would reduce revenues by $1.75 trillion over ten years.
However, with little evidence so far that Congress is moving in the direction of a substantial net tax cut and the continued focus on revenue-neutrality we have seen from congressional leaders, we have reduced our assumption to $1 trillion over ten years, which reflects an expectation of a tax cut that could be considered close to revenue-neutral under the loose definition that congressional Republicans have been using. This could allow for a modest personal tax cut and, with a few budgetary offsets, a reduction in the corporate rate to 28%. We continue to believe that some type of tax legislation is more likely than not to be enacted in early 2018, but this is also now a much closer call than it used to be, in our view.
This smaller fiscal assumption only modestly reduces our estimated fiscal impulse in 2018. We had previously estimated that federal tax cuts would provide a fiscal boost of about 0.3pp, with other factors bringing the total impulse to around 0.4pp. Under our revised assumptions, the effect on growth would be about 0.1pp smaller (Exhibit 2). We note that the effect in 2018 will depend at least as much on when tax legislation is enacted and on the phase-in schedule of tax cuts is likely as it will on the aggregate size of the tax cut over the next ten years.
While the probability of meaningful policy changes has declined, in our view, financial markets seem to reflect even lower odds. Exhibit 3 presents four measures that likely reflect policy expectations: the relative performance of baskets of high-tax stocks (upper left panel) and infrastructure stocks (upper right panel) versus the S&P, constructed by our portfolio strategists; the outperformance of an index of bank stocks versus a model constructed by our equity options research team (lower left panel), and 5-year,5-year forward inflation (lower right panel). The first three represent reflect declining expectations of fairly specific policies. The decline in 5-year, 5-year forward breakeven inflation expectations suggests that the market may have now mostly priced out expectations of the broader macroeconomic effects of the Trump agenda as well. In each case, these measures are just above or below their level on Election Day. This suggests that while the probability of a meaningful tax cut by 2018 has diminished, there is limited risk of policy disappointment given such low expectations.
We also note that while recent events have increased uncertainty generally, the appointment of a special counsel might reduce the risks around the expiration of spending authority on September 30 and the debt limit deadline around the same time. We had expected that congressional Democrats might try to use those upcoming deadlines as leverage to force an independent investigation. However, with a seemingly credible independent investigation underway, the issue is less likely to enter into fiscal negotiations at that point, reducing the odds of a shutdown in early October.