US: Tax reform scope matters more than timing – RBC CM

According to the analysts at RBC Capital Markets, President Trump’s prime-time speech in front of Congress today is garnering an incremental level of fanfare given the prospect for a more detailed timeline on key fiscal initiatives (especially tax reform).

Key Quotes

“News reports suggest White House officials view this speech as an opportunity for the President to pass the policy baton to Congress (after a multitude of unilateral executive actions thus far). Accordingly, it’s expected Trump will outline key fiscal initiatives for the balance of 2017. Consensus is that tax policy is an H1 2018 event at the earliest and thus any concrete impact on these expectations from Trump’s speech should be market moving.”

“What became obvious with the Treasury Secretary Mnuchin interviews (if it wasn’t already before then) is the level of investor obsession with regards to the timeline of tax reform. Though Mnuchin noted the August recess as an ambitious timeframe in which to get tax reform off the ground, this was met with significant skepticism. Taking a view on tax policy timing is fraught with pitfalls—consistent with predicting anything coming out of DC. We think the hyper-focus on timing of tax legislation misses the bigger point. The prominent investment thesis that continues to drive the long-run low real rate environment view is that of secular stagnation. Current tax policy proposals have the potential to flip this on its head. Whether the starting point is later this year or well into 2018 is really irrelevant for the secular narrative.” 

“The secular stagnation thesis was allowed to take hold not only because of the significant overhang of the crisis (massive post credit bubble de-levering) but because DC was out of the game for the better part of the last eight years (with only two major pieces of legislation passed in the early stages of the Obama administration—Dodd/Frank, and the ACA—both of which are largely viewed as punitive for business). This left the Fed on autopilot with a lower for longer mantra (which then fed back into the secular stagnation narrative and, perversely, affirmed it). But secular stagnation is not a new theory.”

“We witnessed similar thinking in the late 1930s in the wake of the Great Depression when the US economy was facing similar “secular headwinds” (slowing population growth, limited innovation). Note that the peak level of interest in this topic back then also coincided with the secular low in long-end Treasury yields. Is it possible that the secular stagnationists have it wrong again? Tax policy would go a long way in shifting this view, whether it happens later this year or well into 2018.”

“Note that "trend growth" is a key driver of the neutral rate and the secular stagnation thesis is a critical driver of this broader thinking. Should we get significant fiscal policy that shifts the growth trend materially, the Fed will have to adjust their neutral rate much higher—which means current policy looks even easier! A shift of this nature has obvious implications for where the cyclical end-point for FF ends up.”