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US Treasuries: Dampener on Trump’s promises

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The Trump administration seems to be  moving away from the president’s radical campaign rhetoric

KEY POINTS

  • The Trump administration is proving more moderate than the president’s campaign rhetoric suggested.
  • Congress has played an important role in constraining the president’s actions.
  • The tax cuts proposed by the Trump administration have proved underwhelming in practice.

Donald Trump’s first 100 days in office proved one thing – his tweet was worse than his bite. The stark contrasts that have arisen in the transition from the campaign trail to the realities of governing for the Trump administration have proved to be unusual if not unprecedented. The separation of powers embodied in the US constitution has constrained the ability of Trump to impose more extreme decisions on virtually every front. 

A telling example is tax reform. There is a broad consensus that reform is long overdue but none on how to do it: the initial failure to repeal and replace the Affordable Care Act (Obamacare) through a Republican-controlled Congress has severely constrained Trump’s room for manoeuvre on fiscal policy. As Arnab Das, head of EMEA and emerging markets macro research at Invesco Asset Management, points out, fiscal saving from repealing Obamacare was intended to enable taxes to be reduced in a deficit-neutral way. Tax cuts only require a simple majority for Senate approval, enabling the Republicans to avoid a Democratic filibuster – if they are offset by spending cuts. The controversial Border Adjustment Tax offers an alternative, deficit-neutral route to tax reform by raising substantial revenue from imports, but is stuck in the swamp of competing interests. 

Instead, Trump may argue that tax cuts and deregulation will boost tax and growth revenue – despite the chequered history of such supply-side reforms. Ronald Reagan’s deregulation and 1986 tax reforms were supposed to have the same effect. The economy grew, but so did the deficit, forcing George Bush senior to break his campaign promise and raise taxes, thereby losing a second term despite presiding over US victories in the Gulf War and the Cold War. 

Trump’s tax reforms had been announced as the “most significant” since 1986 while US Treasury Secretary Steven Mnuchin announced the administration was planning the “biggest tax cut reform in US history”. But the details released in April proved to be underwhelming. “This announcement is a non-event. Just the reiteration of an opening gambit for what will surely be a long and tough negotiation with Congress,” says Didier Saint-Georges, managing director at Carmignac. 

real yields on 10 year us government debt

He adds that the Trump administration will be lucky if the reform gets passed this year, and if it gets half of what it is asking for. 

The bottom line, argues Das, is that all these factors point to boxing-in the more radical elements of the campaign agenda. There is likely to be a much smaller and less comprehensive tax reform, much smaller stimulus and much smaller infrastructure package than outlined in Trump’s campaign promises.

Trump will clearly have difficulties in financing his campaign promises of $1trn (€920bn) infrastructure spending over 10 years. Such expenditure can certainly have an inflationary impact, at least on wages, given that the US economy is already at full employment. However, as Sandra Crowl, a member of the investment committee at Carmignac in Paris, argues, there is still unutilised capacity for production across many industries and with only 75% capacity utilisation rate, there is room for rising output. 

Because of the increased defence spending and planned tax cuts, the key issue she sees is how the Trump administration can afford such spending plans with a fiscal deficit of 3.1% of GDP. The Committee for a Responsible Federal Budget, a non-partisan campaigning organisation, has estimated that the Trump spending plans will add $6trn of new debt. The Congressional Budget Office, a federal agency, projected that debt will grow from $20trn to $30trn between 2017 and 2027. 

What are the alternatives? Financing can come from a mix of public private deals for infrastructure. But Trump’s planned funding cuts to states and services departments such as the diplomatic corps and agriculture can have repercussions over safety concerns in the US. 

Crowl sees that debt ceilings discussions already possible this summer will create volatility. 

Carmignac expects that new government debt issuances to finance government spending will create pressure on bond prices, owing to excess supply as well as potential concerns over the sovereign debt credit rating that was knocked down by S&P from AAA to AA+ in 2011.

As the dollar is the premier reserve currency, there is little danger of a global sell-off. The composition of investors is changing though. China is no longer the biggest holder in US bond holdings, having been overtaken by Japan at the start of this year. China was selling dollar holdings in 2015 and 2016 to support the renminbi, but the imposition of tighter capital controls and more stable capital flows has reduced the requirement to sell US Treasuries.

Perhaps the most surprising development, given the pre-election rhetoric and the initial appointments, is how rapidly the Trump administration is shifting back towards ‘normal’. The balance has swung towards more mainstream figures.

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