US Tax and Budget Policy in focus this week - Nomura

Analysts at Nomura explained that the Senate appeared poised to pass a major tax bill by the start of this week.

Key Quotes:

"Only one Republican senator, Robert Corker (R-TN), is likely to vote against the legislation. From here, the process can go in two directions. Under normal circumstances, a conference committee will reconcile differences between the bills passed in the House and the Senate, before sending a single revised bill back to both chambers for final passage. In addition to reconciling differences, the conference committee will allow the authors of the House and Senate bills a more close review of the legislation, which was drafted in haste without the normal process of review. 

Alternatively, the House may take up and pass the Senate bill, and send it directly to President Trump for his signature. This expedited procedure would eliminate the risk inherent in asking the Senate to reconsider this complicated and controversial legislation. With expected Senate passage, arguably the highest hurdle during the entire tax reform process, we now expect full passage of the tax bill by year end. It will take time to review all of the last-minute changes to the Senate legislation. 

However, in brief, the tax cuts will likely modestly boost real GDP growth in 2018 by a few tenths, although the corporate rate cut delay to 2019 could shift some growth into later years. Separately, Democrat and Republican leaders indicated increased willingness to pass a short-term agreement to fund the government until 22 December. This could reduce the likelihood of a government shutdown when the current deal expires after 8 December. Note that the debt limit, separate from the spending deal, will be reinstated after 8 December but the Treasury will be able to implement so-called “extraordinary measures” to meet its obligations. The debt ceiling likely will not be addressed until Q1 2018.

Monetary Policy 

The FOMC appears set to raise rates again at its upcoming December meeting. With the combination of momentum in aggregate demand, tightening labor markets, some evidence of a rebound in inflation, and resilient financial conditions, we think the FOMC will raise short-term interest rates somewhat more over the next two years than we expected before. Beyond the likely hike in December, we now expect three hikes next year – in March, June, and December 2018 – and one more hike in June 2019. This pace of hikes is in line with the current median of the median FOMC forecasts through mid-2019. Read our full report: Changing our Fed call, Policy Watch, 26 November 2017.

In his confirmation hearing on 28 November, Governor Jerome Powell – President Trump’s pick to succeed Janet Yellen as Federal Reserve Chair – indicated that the trajectory of monetary policy is not likely to change materially if Senate approves his nomination. Governor Powell indicated that the FOMC is likely to hike in December and more hikes are likely, while stating that he remains mindful of low inflation and the possibility of further tightening in the labor market without meaningful acceleration of inflation.

President Trump also nominated Marvin Goodfriend to the Board of Governors. Mr Goodfriend worked for many years at the Federal Reserve Bank of Richmond, more recently has been a member of the Economics Department of Carnegie Mellon University, and has been a member of the so-called “Shadow Open Market Committee.” His previous experience suggests a somewhat “hawkish” inclination. That said, recently Mr Goodfriend has argued that the Federal Reserve must be careful to build its credibility in fighting deflation and therefore should be cautious in tightening policy before inflation returns to its 2% target.1 Conditional on Mr Goodfriend’s confirmation, once Chair Yellen steps down, the Board will still have three vacant seats for President Trump to fill. 

Finally, at her testimony before the Joint Economic Committee, Chair Yellen reiterated the FOMC’s consensus view on the labor market and inflation outlook. Looking ahead, with her term expiring on 3 February, she will likely only reiterate the FOMC's most recent views at any upcoming speeches and is unlikely to signal a material change in policy outlook.

Other Developments in Washington 

Former National Security Director Michael Flynn pleaded guilty to lying to the FBI regarding contacts he had with Russian official before Donald Trump became President. Mr Flynn’s plea deal indicates he is actively cooperating with Special Counsel Mueller’s investigation. This development brings the Mueller investigation closer to President Trump’s inner circle. No doubt this will be an ongoing distraction for the White House and an obstacle to positive policy making. That said, it is not obvious that it increases materially the chances that President Trump will leave office prematurely."