US: A fiscal festivus for the economy – TDS

Analysts at TDS note that the US Congress has passed nearly $1.5 trillion in tax cuts over 10 years, which President Trump is expected to sign into law by early next year.

Key Quotes

“The economic stimulus from this plan is likely to be limited in our view: it should add 0.1 to 0.2pp to real GDP growth in 2018 and 0.2 to 0.4pp in 2019. We also see a somewhat higher risk that it will boost inflation than it would raise potential output over the next several years.”

“Fed officials have largely incorporated the tax plan into their most recent projections, but that has not resulted in the FOMC anticipating additional rate hikes for 2018 or 2019. We currently expect two rate hikes next year but see upside risk for an additional Fed rate hike in 2018 if the realized stimulus effect is larger than we anticipate.”

“Concluding a tax deal does not appear to make it any easier to reach agreement on a continuing budget resolution (and thereby avoiding a shutdown) or the debt limit. In fact, Republicans are split over how to proceed on these issues. We expect another short-term budget extension into early next year, then a more protracted battle over a number of contentious issues. A shutdown sometime over the next month remains a possibility.”

“We expect higher deficits to be largely funded in the sub 5y sector. This should help bear flatten the 5s30s curve and cheapen 2y Treasuries versus OIS. Repatriation of overseas profits should lower total non-financial corporate issuance. That should be a positive for corporate spreads. However, repatriation could also create some USD funding pressures for foreign banks. This should keep FRA-OIS and EUR USD cross currency basis wide even beyond year end. We remain long June 2018 FRA-OIS. We expect Fannie and Freddie to mark down their deferred tax assets and draw about $20bn combined from Treasury in 1Q. This can create some negative GSE headlines, but we don’t expect much of a market reaction. This is a well anticipated loss and Treasury has enough available support. GSE reform looks unlikely in a midterm election year.”

“While we think FX markets are largely unfazed by the passage of this bill, our concern on the USD stems from funding risks. Beyond that, provisions related to repatriating cash, twin deficit concerns, and a global growth/central banking backdrop that remains supportive of a rotation in capital flows offer medium-term offsets.”