A One-Year Look at President Trump’s Economic Policies
This special report from J.P. Morgan’s Global Research Department, which can also be found on J.P. Morgan Markets, provides an analysis on U.S. President Donald Trump’s policy initiatives and proposals one year after taking office.
January 12, 2018
One year after the U.S. elections that brought Donald Trump into office, Congress has passed comprehensive tax reform, which is making history for the size of the corporate tax cuts that bring statutory rates to their lowest level since the pre-war years. Apart from tax reform, there have been few legislative changes and other policy priorities with varying degrees of success. President Trump’s stance specifically on trade has not resulted in material, concrete actions to restrict it. Emerging Markets ended the year as the top performers across equities and fixed income as the post-election surge in the U.S. dollar has more than fully reversed despite Trump’s “America first” strategy, with the J.P. Morgan U.S. Dollar Index marking its first down year since 2012.
With the passage of tax reform, there is renewed debate on whether fiscal stimulus reflation forces that markets had anticipated in 2017 could play out over the next year. J.P. Morgan’s Global Research team believes that tax reform translates into a modest boost (0.3%-pts) to U.S. growth for 2018, but it means more for equity market returns as tax cuts are positive for equities, while the reduction in interest expense deductibility is a negative for credit.
In 2018, U.S. growth should remain comfortably above our 1.4% potential growth estimate, while the unemployment rate should continue its descent to 3.7% by the end of 2018. The Fed, under the expected new Chair Jerome Powell, is unlikely to wait to see high inflation before acting, and we believe that they will continue to deliver a hike per quarter next year to bring the Fed funds rate closer to a neutral setting, given the solid trend in employment growth and a tighter labor market.
While it remains J.P. Morgan Global Research’s view that 2018 will not be the year of the “Trumpflation” trade, we expect an uptick in near-term volatility, rather than a shift in medium-term trends. Trade policy changes with material economic impact remain unlikely, but the dialogue around U.S. bilateral trade relationships with every major country, including China, has been reshaped in less than a year, and downside risks linger with markets focused on the North American Free Trade Agreement (NAFTA) renegotiation. In addition, the ongoing special counsel investigation headed by Robert Mueller will likely remain a source of recurring, but random, market stress because it can occupy time and resources from an otherwise transformative policy agenda.
We forecast U.S. growth at 2.3% year-on-year in 2018, which is about 1%-pts above our estimate of sustainable-trend growth. If our forecast is realized, the expansion will enter its tenth year in the second half of 2018 and will become the second longest U.S. expansion on record.
The legislation targets a $1.5 trillion increase in total deficits over the next ten years and includes roughly $500 billion that we would chalk up to the continuation of existing policies (notably in the form of “bonus” depreciation deductions and other “tax extenders”), with the top corporate tax rate coming down from 35% to 21%. With annual U.S. GDP of about $20 trillion, a $100 billion tax cut represents 0.5% of GDP. We see a modest boost to 2018 U.S. GDP growth of only 0.3%-pts given companies’ limited propensity to invest when they are not particularly cash-constrained.
The Senate Banking Committee recently approved the nomination of Jerome Powell to be the next Fed Chair; he is expected to be confirmed by the full Senate before Janet Yellen’s term expires in February. Though Randy Quarles filled a governor’s seat at the Fed, there are still three other vacancies on the board, which leaves the White House the ability to potentially reshape the Fed for many years to come. We forecast the Fed will hike rates four times during 2018, based on diminishing slack, rather than overheating risk from fiscal stimulus. Modest stimulus from tax reform shouldn’t lift inflation beyond the baseline rise to 1.8% on core personal consumption expenditures next year.
Since the presidential election, there have been no trade policy changes with material economic impacts, but trade has been continually monitored as a source of downside risk. One year into the administration, there has not been any material concrete actions to restrict trade. In the fourth round of NAFTA negotiations, U.S. negotiators made aggressive demands for new requirements in auto trade, changes to the dispute resolution mechanism and government procurement rules, and a five-year sunset clause for the entire agreement. The next round of NAFTA negotiations resumes in mid-January, with the final round scheduled before the end of 1Q18.
While it is possible that a new NAFTA will be negotiated in 1H18, there is still a significant risk that the agreement is terminated or replaced with a new version that negatively impacts trade.
There has been a rise in geopolitical tensions between U.S and North Korea, Iran and Venezuela, with increased sanctions being placed on all three countries. Although these sanctions have had little impact on the first two countries thus far, we expect Venezuela’s oil production to be impacted in the future.
Brent is up by nearly 50% since President Trump’s election on November 7, 2016. However, oil prices have relied more on the strengthening fundamental outlook for the oil market than on U.S. policy developments. While many of the choices made by President Trump since the election should have a bearing on prices in the coming quarters, the more important choice was made last November by the Organization of the Petroleum Exporting Countries (OPEC) to shift output policy in support of prices. The nine month extension of the current OPEC-NOPEC deal should support prices into a higher range in 2018 (mid-$50s to mid-$60s). We expect Brent to average $60/bbl and WTI to average $54.9/bbl in 2018 to factor in the commitment on the inclusion of Libya and Nigeria in the revised OPEC.
Of President Trump’s campaign promises, the likely ramp-up in protectionist trade measures and a potential increase in fiscal stimulus would likely have the greatest effect on base metals. However, new policies from the Trump administration had even less of an impact on base metal prices than expected, as both trade policy and stimulus measures had been stalled behind other legislative priorities such as health care and tax reform. Gold has traded in a range between $1,200/oz and $1,350/oz for the past nine months. The largest driver for gold in the near term likely will be Fed repricing U.S. real rates, which should push prices lower. While trade protectionism would likely be bearish for pricing and stimulus would likely boost prices, the fundamental base metals impact by any sort of boost in infrastructure spending would likely be prolonged and not extremely influential to the global demand for industrial metals.
The market would be more focused on:
After Trump took office, our U.S. equity strategists had a positive view on Growth and Momentum Styles, arguing that a maturing business cycle favors Growth over Value. Growth outperformed Value by ~14% in 2017. We view U.S. tax reform as the most significant upside catalyst for equities and have raised our end-2018 baseline S&P 500 projection to 3,000. We now advocate fully rotating into Value from Growth as Value companies should see the greatest EPS benefit from tax reform given that it has the highest domestic revenue at 76.9% (of total revenue) and carries the highest effective tax rate of 30.3% relative to other styles.
We recommend Overweight positions on reflation-sensitive domestic sectors such as Financials, Energy and Materials and Industrials. We have downgraded Growth stocks and are now Underweight multi-nationals such as Technology and bond-proxy pass-through sectors such as Staples, Utilities, and REITs, while moving Healthcare to Neutral. Recent U.S. macro data reflect a more favorable backdrop for Value with prospects for reaccelerating growth into 2018.
Our EM Equity research team sees EM equities delivering double-digit appreciation in 2018 (USD+12% upside), driven by earnings growth and modest room for multiple expansion. EM equities ended 2017 as the top-performing asset class returning a total of 34%, although the Trump administration will remain a source of volatility and potential downside risk related to trade policy into the new year. The pro-growth agenda is positive for global equities, particularly U.S. equities, and supported by the passage of favorable tax reform, deregulation and fiscal spending. However, the negative risk to EM equities is slower economic growth led by possible restrictive trade policies, e.g. NAFTA at the forefront and targeted sanctions. Restrictive trade policies could have a long-term unintended negative impact on global growth and bias EM national elections toward nationalist behavior and disaffection with conventional policies, which could impact continued EM equities outperformance.
FIXED INCOME VIEWS
We believe that the Fed will march forward on rate normalization. We project the Fed to raise rates by 25bps at each of the four long-form meetings in 2018, leaving the Fed funds target range at 2.25-2.50% by the end of next year. In addition, we expect the Fed’s balance sheet to shrink by nearly $400 billion, 9% from its size at the end of 2017. In contrast to 2017, the Federal Open Market Committee may actually deliver on the number of hikes it has projected for 2018.
The continued rise in yields has been driven by:
Both High Grade and High Yield spreads have rallied on the U.S. strong growth trend and the expectation of pro-business tax policy and regulatory initiatives to come. One surprise in 2017 was a slowdown in M&A activity, which has been attributed to the uncertainty on tax policy and on healthcare reform. M&A picked up again with tax reform moving forward, and we expect increased M&A to be a theme in 2018. There is some regulatory uncertainty on this, however, with the unexpected challenge by the Department of Justice to a large merger in the Telecom/Media space. In terms of trade, NAFTA negotiations will remain on the radar for some corporate bond issuers, particularly in the Automobile Manufacturing and Agriculture sectors.
With the passage of tax reform, we believe it will likely have more impact on bond supply than on corporate creditworthiness for the High Grade bond market. An important aspect of the U.S. tax bill impacting High Grade bond issuers is the cash repatriation provisions which, in our view, will likely:
Another important aspect is the limit on the deductibility of interest expense by corporates. High Grade companies are unlikely to be impacted, but some High Yield issuers will be impacted by the limit on the deductibility of interest expense at 30% of EBITDA (for 2018-2021), and then by the exclusion of depreciation and amortization (EBIT) from the calculation in future years. The limitations on interest deductibility are an issue for the most stressed CCC-rated issuers. Meanwhile, there are several credit positive elements in the tax bill, which include a reduction in the corporate tax rate to 21% (from 35%) and the ability to fully deduct capex in the year spent for the next six years.
The post-election surge in the U.S. dollar more than fully reversed as it had fallen by 7.1% in 2017, marking the first down year since 2012. We expect U.S. dollar strength in the first half of the year as the Fed proves the only major central bank adjusting policy. In the second half of the year, U.S. dollar weakness could play out as policy normalization elsewhere comes into focus through European Central Bank balance normalization and a possible hike in the Bank of Japan yield target.
A variety of idiosyncratic risks could continue to drive the dollar, but we point out that one year into the Trump administration, the president’s policy initiatives are producing more noise than impact, and thus, more near-term volatility than medium-term trend. Washington’s policies are more risks to the baseline forecast, with potential surprises from tax reform implementation and various other issues including trade policy, the ongoing special counsel investigation headed by Robert Mueller and fiscal risks.
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