It took the market about 6 months to realize that contrary to initial expectations, Trump’s fiscal reform would be substantially delayed and implemented in 2018 at the earliest, if at all. Next, it’s time to take the machete to the total size of the program, which is what Goldman’s chief political economist Alec Phillips did today when he reported that Goldman is lowering the firm’s expectations for fiscal policy changes over the next year: “Rather than the $1.75 trillion/10 years tax cut we had previously assumed, we now assume a cut of $1 trillion” or a cut of over 40%. This reflects an expectation of a tax cut that could be considered close to revenue-neutral under the loose definition that congressional Republicans have been using.
What prompted the revision? The recent chaos in DC of course:
Recent developments regarding the investigation into the Trump campaign have further weighed on a fiscal policy process that was already bogged down by House passage of the AHCA, which will consume valuable time in the Senate, an uncertain outcome on the FY18 budget resolution, without which tax legislation would become much less likely, and a lack of clear forward movement on tax reform.
As a result, this is Goldman’s new base-case for Trump reform:
the probability that tax legislation will be enacted by 2018 has fallen further, in our view, as a result of recent events. The last few weeks have taken a toll on President Trump’s approval rating as well as support for Republicans in Congress…. Over the last week, the President’s approval rating has averaged around 40%, and Democrats have led generic ballot polls over the last week by an average of 11 points.
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It is also not clear how much support there will be for a simple tax cut. The White House has proposed a tax cut that we expect might cost $3-4 trillion over ten years but House Republican leaders have insisted on revenue-neutral tax reform that does not add to the deficit and earlier this week, Senate Majority Leader Mitch McConnell called for revenue-neutral tax reform as well. While their definition of “revenue-neutral” includes dynamic scoring and other technicalities that might be worth several hundred billion dollars over ten years, even under a loose definition of “revenue neutral” this would seem to preclude a substantial net tax cut.
In light of these developments, we are changing our fiscal policy assumptions. We already assigned a very low probability to comprehensive tax reform by 2018 but recent events make it even less likely in our view. Our base case has been that Congress would enact a reasonably simple corporate and individual tax cut, with incremental reform—limited base broadening and international corporate reform—that would reduce revenues by $1.75 trillion over ten years.
However, with little evidence so far that Congress is moving in the direction of a substantial net tax cut and the continued focus on revenue-neutrality we have seen from congressional leaders, we have reduced our assumption to $1 trillion over ten years, which reflects an expectation of a tax cut that could be considered close to revenue-neutral under the loose definition that congressional Republicans have been using. This could allow for a modest personal tax cut and, with a few budgetary offsets, a reduction in the corporate rate to 28%. We continue to believe that some type of tax legislation is more likely than not to be enacted in early 2018, but this is also now a much closer call than it used to be, in our view.
This is what the shrinking Trump Bump will look like as a result:
A Shrinking Trump Bump
That said, none of this will come as a surprise to the market which no longer expects virtually anything from Trump on the economic front, as confirmed by market expectations which have declined even more, and do not imply much if any assumptions of tax reform, infrastructure spending, or financial regulatory easing. Some more color:
While the probability of meaningful policy changes has declined, in our view, financial markets seem to reflect even lower odds. Exhibit 3 presents four measures that likely reflect policy expectations: the relative performance of baskets of high-tax stocks (upper left panel) and infrastructure stocks (upper right panel) versus the S&P, constructed by our portfolio strategists; the outperformance of an index of bank stocks versus a model constructed by our equity options research team (lower left panel), and 5-year,5-year forward inflation (lower right panel). The first three represent reflect declining expectations of fairly specific policies. The decline in 5-year, 5-year forward breakeven inflation expectations suggests that the market may have now mostly priced out expectations of the broader macroeconomic effects of the Trump agenda as well. In each case, these measures are just above or below their level on Election Day. This suggests that while the probability of a meaningful tax cut by 2018 has diminished, there is limited risk of policy disappointment given such low expectations.
Aside from economic implications, Goldman also echoes what we said after news of the Special Prosector broke, saying that “while recent events have increased uncertainty generally, the appointment of a special counsel might reduce the risks around the expiration of spending authority on September 30 and the debt limit deadline around the same time. We had expected that congressional Democrats might try to use those upcoming deadlines as leverage to force an independent investigation. However, with a seemingly credible independent investigation underway, the issue is less likely to enter into fiscal negotiations at that point, reducing the odds of a shutdown in early October.”
Goldman, which incidentally also happens to run the country by way of Gary Cohn and Steven Mnuchin, may be overly optimistic on this however: there are four months to go until the next government shutdown scare, and if recent history is any indication the negative surprises out of Trump assure that the next government shutdown is a question of when not if.