US: Odds of tax cuts passage have improved - BBH

The prospects that the Republican-controlled legislative branch would find a compromise to tax cuts were enhanced when a few senators appeared to capitulate without much to show for it, notes the research team at BBH.  

Key Quotes

“This may have helped lift US stocks and dollar ahead of the weekend.  Each chamber must now approve the reconciliation measure, which does not look particularly like either the House or Senate bills, though the regressive thrust was maintained.”

“Passage will be relatively easy in the former, but it will be a close call in the Senate.  There are a few Republican Senators that do not face re-election, like McCain and Flake from Arizona and are not subject to party retaliation.  Still, despite "maverick" rhetoric, and others professing concern about the resulting deficit, the odds of passage have improved.”

“At the same time, the Federal Reserve raised interest rates and the median Fed forecast was for three more hikes next year.  This combination of expanding fiscal policy and tighter monetary policy is associated with an appreciating currency.  As we have pointed out before, the two "textbook" examples are the Reagan-Volcker mix of the early 1980s and the terms of the reunification of Germany in the early 1990s.  A year ago, many investors were led to believe the fiscal expansion was going to be delivered in 2017.”

“The failure to deliver this stimulus in this year and recovery of the anxiety over European politics since the Dutch and French elections in the spring are reasonable factors behind the poor dollar performance.  Indeed, the euro is the strongest of the major currencies this year.   It appears that early 2018, attention will turn to the other leg of the fiscal stimulus--an infrastructure initiative.  A public-private partnership is consistent with the signals from the White House, which could see around $200 bln from the federal government, though it may be cannibalized from some current programs.”

“We agree with those that do not expect the tax adjustment on overseas profits by American companies to boost the dollar directly or fuel much investment.  The direct impact on the dollar is limited by the fact that most of the estimated $2 trillion overbooked abroad is kept in dollar-based investments.”

“The jaundiced eye toward the prospect of an investment spree is derived from experience.  Research of the 2004 tax holiday, for example, cited by the Wall Street Journal, found that for every dollar repatriated, 79 cents went for repurchasing shares, and another 15 cents went towards dividends.  The research found no increase in domestic dividends.  Also, as reported ahead of the weekend, US industry is operating at a little more than 77% of capacity.  The last cyclical expansion saw capacity utilization rates exceed 80%.”

“There may be an indirect impact on the dollar from the changed tax regime for internationally booking profits.  It may come through the current account narrowing as investment income is repatriated.  Traditional models of valuation in the foreign exchange market emphasize the basic balance as a key driver of movement in the foreign exchange market.”

“The recent string of economic data suggests that the synchronized economic expansion in the US, Europe, and Japan is strengthening as the year winds down.  The stronger than expected US retail sales report points to a strong personal consumption report this week and prompted economists to revise up estimates for Q4 US GDP.  The Atlanta Fed sees it tracking 3.3%, while the New York Fed sees 4.0%.  The NY Fed also projects Q1 18 growth of a little more than 3%.”