Latest Republican tax plan is again light on details but at least drops the BAT idea — Republican leaders Thursday afternoon released a 5-paragraph statement of principles on tax reform that was again short on details. There was no mention of a specific corporate tax rate or any details on an overseas cash repatriation program, which are the main items of interest for the stock market.
However, the statement did state that the border adjustment tax (BAT) idea has been dropped from consideration. That was good news for the stock market in our opinion because we believe the BAT would have been a disaster for the U.S. economy and would have riled the financial markets with unnecessary dollar strength. However, dropping the BAT idea also had a negative implication for tax reform because its $1 trillion of revenues over 10 years will not be available as an offset for larger tax cuts. In the end, the death of the BAT idea was roughly neutral for the markets because there was so much bipartisan political opposition to the idea that it was unlikely to go forward in the end anyway.
The statement also said that one of the goals of the plan is to place “a priority on permanence.” That indicated that Republicans will try to come up with a balanced package that doesn’t increase the federal budget deficit. While a worthy goal, we still suspect that Congress in the end will have a hard time finding revenue-raisers and will rely in part on a 10-year tax cut such as the one that President Bush implemented.
Thursday’s vague statement of principles shows that Republican negotiators still have a long way to go before coming up with a detailed plan that will be accepted by enough Republicans to squeak through Congress.
Meanwhile, House Speaker Ryan ran into opposition this week to his 2018 budget resolution, which will apparently now be deferred until September. That resolution is critical for tax reform because it is the legislative vehicle for tax reform to pass through the reconciliation process, which avoids a Senate filibuster by Democrats.
U.S. Q2 GDP expected to improve to +2.5% after Q1 dip — The market consensus is for today’s Q2 real GDP report to improve to +2.5% (q/q annualized) from Q1’s weak report of +1.4%. The improvement in Q2 GDP is expected to stem largely from stronger Q2 personal consumption growth of +2.8% after U.S. consumers went AWOL in Q1 with spending of only +1.1%. There will be GDP revisions released today for 2014-2016 that could have some market impact.
Today’s expected improvement in Q2 GDP to +2.5% is actually less than impressive given that the growth rate for the first half of 2017 would be just +2.0%, which is just slightly above the Fed’s estimate of +1.8% for the long-run U.S. GDP potential. In addition, the Atlanta Fed’s GDPNow estimates that +0.5 point of today’s GDP growth will be caused by inventory accumulation, meaning that today’s GDP report ex-inventories is expected to show a rise of only +2.0%.
The markets will be hoping for another strong contribution to Q2 GDP growth from business investment. GDPNow is forecasting a +0.5 point contribution from investment in Q2, adding to the strong +1.7 point contribution seen in Q1. The U.S. economy needs strong business investment so that economic growth is more balanced and is not solely dependent on consumer whims.
Looking ahead, the market consensus is for relatively strong GDP growth in the second half of 2017 of +2.4%, leading to an overall 2017 annual GDP growth rate of about +2.2%. The market is then expecting GDP growth to improve slightly to +2.3% in 2018 before falling back to +2.0% in 2019. GDP forecasts for 2018-19 are up in the air to some extent because of uncertainty as to whether Republicans will approve stimulative tax cuts for next year.
Final-July U.S. consumer sentiment expected little changed — The market consensus is for today’s final-July University of Michigan U.S. consumer sentiment index to fall by -0.1 point from early-July to 93.0, which would leave the index down by -2.1 points from June rather than the preliminary decline of -2.0 points.
The consumer sentiment index soared by +11.3 points after the Nov-2016 election to a 13-1/2 year high of 98.5 in January. However, the index has since sagged by a net -5.4 points to 93.1 as some of the election euphoria wore off due to the slow growth Republican agenda and Washington political uncertainty in general. Still, U.S. consumer sentiment remains historically strong due to the strong labor market, record highs in the stock market, rising home prices and household wealth, low gasoline prices, and hopes for a personal income tax cut next year.
U.S. ECI expected to show solid growth — The market consensus is for today’s Q2 employment cost index (ECI) to show an increase of +0.6% q/q and +2.4% y/y, softening a bit from +0.8% m/m in Q1. On a year-on-year basis, the ECI in Q1 perked up to a 2-year high of 2.4% y/y, which provided some evidence of rising salaries and benefits.
However, that +2.4% y/y growth rate is still well below the average gain of +3.6% seen in 2000-2007 before the Great Recession, illustrating that wage and salary growth remain sub-par. The Fed continues to search for reasons why wages and salaries are not rising more quickly in response to full employment in the economy. In the meantime, modest wage gains are helping to hold down U.S. inflation and are a dovish factor for Fed policy.