US travel note Tax cuts are coming but will be watered down

• Most economists think the US expansion is going to continue in coming years with growth above potential and see few risks near term.

• Most expect the Republicans to deliver a deficit-financed tax cut (most realistically in Q1 18), as they are afraid of the mid-term election in November next year. However, the final version is likely to be watered down (in terms of how big cuts they can make), as there is opposition to the tax revenue raises (like removing tax deductions). Growth impact is expected to be small both in the short and long run so it should not mean a lot in terms of Fed policy. This also limits how much it should push up US yields.

• Economists – including at the rating agencies – do not seem to be concerned about increasing public debt despite US public finances being unsustainable to begin with already under current law. One reason is that interest payments in percent of GDP are low due to low rates.

• Jerome Powell was the safe choice for the next Fed Chair and will continue the current monetary policy strategy but will rely more heavily on staff compared to Yellen or Bernanke. Do not expect any controversial nominations for the vacant Fed seats.

• Low probability of a trade war with China. NAFTA is a ‘joker' (not least with elections in Mexico next year), which may disrupt US supply chains but analysts expect the US to remain in NAFTA.

Expansion set to continue in coming years

The consensus view is that the US expansion is set to continue in coming years with growth above 2% (potential growth is 1.75-2.00%, according to consensus). Confidence is high among consumers and businesses, suggesting growth will be driven more balanced between private consumption and business investment, as the oil sector has rebounded after the downturn due to sharp oil price drop. The oil sector has become more important for the rest of the economy, as shale oil production requires more input from the rest of the industrial sector than traditional oil production. Economists in general do not think there are many risk factors out there at the moment but mentioned the Chinese debt situation, increasing US rates and NAFTA (North American Free Trade Agreement) as three potential risks. US economists are also still worried about the political situation in Europe, with both the Catalonian crisis and Italy mentioned.

In terms of the Fed, most expect two to three hikes next year (in line with our view), as inflation rebounds and Powell is not expected to change the current monetary policy strategy. That said, we met a few suggesting the Fed could hike four to five times, as they expect higher-than-consensus wage growth and inflation. Others were sceptical to this view, as they think markets are not prepared for so many hikes and it could lead to a stronger USD, which would slow growth and inflation.

Download The Full Flash Comment