2016/08/24 Commentary: Fed-ticipation
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COMMENTARY (Non-Video): Wednesday, August 24, 2016
Fed-ticipation
There is a radical thought here. Yet that will keep until we explore the reason for many market participants frustration: Fed-ticipation. That’s the attempt to understand what the US Federal Reserve is likely to do next... and when. The term is a pun on the old Carly Simon song Anticipation. While the overall topic of the song is on a wholly different aspect of interpersonal relations, the refrain has a very interesting couple of lines that relate to the current frustration with a Fed whose minions seem to be on so many sides of the rate hike fence that they don’t know where the fence is anymore.
That would certainly be true of both Messrs. Williams’ and Dudley’s hawkish comments right in front of what were significantly dovish FOMC meeting minutes last Wednesday afternoon. Mr. Dudley’s flip-flops have been particularly egregious for anyone looking for a consistent insight on Fed policy. And since the minutes release we have heard from Fed Vice Chairman Fischer that “We are close to our targets”, also implying a rate hike might be reasonable sooner than not.
All of the others’ comments might seem little more than folderol once the annual KC Fed Jackson Hole Policy Symposium begins in earnest on Friday. And who should one of the more prominent early speakers be? None other than Fed Chair Yellen. At 10:00 EDT she will espouse on “The Federal Reserve’s Monetary Policy Toolkit.” And of course, that will not merely be an academic exercise. It will be heavily scrutinized for hints on whether the Fed will be raising rates in September or as a last ditch gesture in December.
Yet it is also a measure of just how much the portfolio management and investor classes are mesmerized by a Fed marginalized through its misguided ‘normalcy bias’. The Fed desperately wants everything to be back to ‘normal’ in spite of indications to the clear indications the economy is not really fully recovering under the current program.
So it’s back to Fed-ticipation, with the refrain parody only being the substitution of the title word: Fed-ticipation, Fed-ticipation, “Is makin' me late, Is keepin' me waitin'.” Little doubt some who have worried about a Fed hike have been late to the bullish equities party, and that the Fed has kept us all waiting endlessly for much touted rate hikes. Keep in mind that at the time of the December rate hike there were supposed to be four of them this year.
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NOTE: Back on the evening of December 8th we posted our major Extended Perspective Commentary. That reviews a broad array of factors to consider Will 2016 be 2007 Redux? For many who believe that the US economy is really strengthening and can once again lead the rest of the world to more extensive recoveries, this may seem a bit odd.
Yet there are combined factors from many areas we have been focused on since the early part of last year which are less than constructive for the global economy and equity markets. We suggest a read if you have not done so already.
We pointed out in December in the face of another likely Santa Claus Rally this was not an actionable view during the year-end equities rally. Yet it was (and remains) important background to utilize into 2016. This is much like our major late 2006 perspective on Smooth Rebalancing? …or… The Crash of ‘07? In that instance the economic factors built up, but the actual crash was deferred into 2008. It is starting to feel this one may be deferred as well.
▪ The Fed’s inability to raise rates in spite of its pressing ‘normalcy bias’ gets back to the radical thought on why the equities might be able to maintain their rally in spite of weak economic news at times and the overall drop in corporate profits for more than a year. (For much more on the Fed’s ‘normalcy bias’ see our December 8th and 16th posts prior to and after the first FOMC hike in almost a decade.) It is not that the Fed will maintain low rates, as similarly low rates and extensive QE elsewhere has not restored robust growth.
The ‘radical thought’ is rather that the equities are continuing to grind their way higher due to an against the odds (the current ones at any rate) possibility that Donald Trump will be the next President of the United States. Before those of you who are appalled by that idea stop reading, think about alternative programs being proposed by major candidates. And before we even get started, this is not a political endorsement of either side or a prediction. It is merely a baseline assessment of how the US economy (and the rest of the world in its wake) might respond to the basic outlines of the alternatives.
Four More Years?
So first we should consider what Secretary Clinton is proposing. We need to allow that she has been dragged to the Left by the success of defeated rival Senator Sanders. Yet her focus now is on more of the same we have seen in the Obama administration and more. To facilitate more government support (code language for government controlling more of the economy) she has been very clear that she intends to raise taxes and continue heavy regulatory intervention in the economy. Of course, that especially means the financial sector and energy businesses, etc.
Little focus has been provided to the impact of those measures on the economy. While it is a bit of a technical detail that many outside of the US (and even many residents) do not understand, taxing the ‘rich’ means taxing small businesses. That is due to the ‘pass through’ corporate structure that many small businesses use to consolidate the taxes under the business owner’s personal tax regime rather than pay separate corporate tax.
The problem for the broader economy is that small business is a driver for employment. And for the first time since records were kept more have closed than opened of late. So much for the success of the US economy in spite of the nominal job gains since the Great Recession that the Obama administration highlights. In spite of Ms. Clinton’s campaign promises of free college, higher Social Security payments and all manner of other goodies, the idea this will also create “more good jobs” is specious at best. Why would things that haven’t worked over the last eight years begin to work in 2017?
A Real Change
While he has softened his tone of late, there is rightful trepidation over whether an overconfident and bombastic Trump who has offended major groups along the way can possibly be a ‘unity’ President. We also need to allow that the Trump economic proposals have their flaws. Not the least of those is the concerns over whether his aggressive stance on renegotiating trade deals might trigger a global tariffs war. No small thing.
There is also the degree to which his seemingly productive tax reform plans would create an even larger US national debt through years of deficits. Of course, the latter depends on whether the US economy returns to more aggressive growth. The Fed would obviously appreciate that move into territory that would finally allow its wished for ‘normalcy’ to be more than just its bias. And as far as the budget deficits are concerned, they might be heavily mitigated by any growth that is more than many would project at present (even under a muted dynamic analysis.)
However, that better than expected growth is exactly what occurred under the Kennedy and Reagan tax reductions. Those turned out to be triggers for a virtuous circle of investment and hiring that outperformed any of the pre-tax cut projections. In spite of all the ‘jobs’ programs that have been instituted by government over the years and even massive monetary stimulus that has added many billions to the major central banks balance sheets, business capital investment has been the only major influence that brings about sustained economic growth.
This is why we have been so focused on the necessity of structural reform since early last year to reinforce all of the central bank efforts. We are now seeing that the central bank efforts on their own cannot restore anything near the pre-Crisis growth. While the Occupy Wall Street and other socialist movements would abhor allowing business to keep more of its earnings, along with regulatory reform that is likely the only path back to prosperity.
Repatriation and Investment
While Trump has not made a major point of it (at least not yet), consider the implications of his proposed 15% top corporate tax rate on the incentives for business on multiple levels. The first is whether that might entice corporate America to finally bring back some major portion of its Brobdingnagian holdings in offshore subsidiaries? In late 2015 that was estimated to be $2.1 trillion.
If memory serves us well, there was a reduced tax rate corporate profit repatriation regime in 1993 that saw many billions of US corporate holdings return home. While this distorted the US dollar, it was worth it. It would certainly help now under further assumptions.
Those would need to include the attractiveness of the proposed 15% top corporate tax rate on the incentives for business to invest the repatriated funds rather than just distribute them as dividends. If a company can keep that much more of what it earns, the ‘risk calculus’ on capital investment becomes much more attractive. In our experience, once one or two companies in a field begin expanding the rest feel they need to do the same to maintain a competitive footing.
Even beyond the tax rate, there would need to be some assurance of a regulatory rollback from the extreme regulation bloat of the past eight years. Along with healthcare reform to lower those costs from the now burgeoning (misnamed) Affordable Care Act expense, corporate America might renew its willingness to take risks on business expansion.
As an aside, this would also automatically eliminate the corporate ‘tax inversion’ domicile change incentives. With an average OECD corporate tax rate of 23% the efforts to punish those companies who want to leave the US (for the benefit of their shareholders) have only had limited impact on preventing the inversions. The lower proposed tax rate would likely entice some previous flight to reverse, and even attract foreign investment.
A Real Difference
The contrast is fairly stark. More of the same that has only allowed for mediocre growth in the US amidst a lackluster labor market is not an attractive alternative. While the headline BLS Employment reports have looked fairly upbeat, the slippage in US median income for the first time since WWII belies a slippage in middle class living standards. That is a big driver for the still less than compelling support for Donald Trump’s Presidential bid.
At least in the economic plans there is a real choice. While both candidates have more negatives than any US Presidential election at any time in memory, their personal and political foibles are not going to make much difference to the US economy. If some of the weaknesses in Donald Trump’s plans can be either mitigated (especially less contentious trade arrangement confrontation) or turn out to be more constructive (higher growth offsetting the potential budget impact of lower tax rates), then his is the better plan for a US economy that remains lackluster under the current higher tax and more expansive regulation regime.
With key UK and US inflation data already priced in today, the Market Observations below are also fully updated to reflect the Evolutionary Trend View.
Extended Trend Assessment is available below.
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