- Rhetoric vs. Policy: The Trump economic agenda was once viewed with promise from the business community, but the President’s rhetoric is threatening the future of his Administration.
- NAFTA & Trade: Trump’s approach to NAFTA is a sign of things to come in his administration’s approach to trade. The first of four rounds of negotiations have kicked off and it’s going to be a rocky ride.
- Tax Reform: Find out which tax proposals are no longer in play and those still on the table. Tax reform will be much harder to achieve than anticipated.
- Bank Regulation: Amending the Volcker Rule may still have a chance due to the influence of a certain US bank’s powerful alumni. The Treasury Department has laid out plans for foreign investors, financial regulation and red tape, and new Russian sanctions have set the tone for the future of Trump’s relationship with Moscow and businesses in Europe.
- Debt Ceiling & US Budget: Arriving back from summer recess, Congress had only 12 days to pass a budget and raise the debt ceiling, but Donald Trump reached an impromptu agreement with congressional leadership to extend both for three months. The catch: The deal was reached with Democrats, to the shock of Republican leaders. What does this mean going forward for the already toxic relationship between this president and congressional leaders in his own party?
Rhetoric vs. Policy
Since January 20th, a reoccurring cycle has taken place in the process of policymaking in the Trump administration: (1) The White House announces a themed week or policy rollout (i.e. Infrastructure Week, executive orders), (2) US President Donald Trump (POTUS) tweets or makes unrelated remarks, throwing the White House messaging off track and distracting from the theme, (3) this results in a further stalling of the Administration’s political, security, and economic agenda (4) repeat steps 1 – 3.
Upon his election, institutional investors had reason to be optimistic about parts of the Trump policy agenda. There was belief that his presidency would provide clarity on items such as healthcare, tax reform, financial regulatory policy, trade, and opportunities through infrastructure spending.
High post-election trading volume led to strong Q4 2016 revenue results from the largest US financial institutions, further boosting optimism under the “Trump bump”. The potential passage of such an agenda was initially seen as a positive for markets with hopes of offering regulatory clarity and the perception of a White House that would be friendly to business following the appointments of key former executives from the finance and corporate community.
Eight months since Inauguration Day, clarity is the opposite of what’s occurring and political uncertainty has left market participants feeling less confident in Washington’s ability to get anything done. Not to mention, the White House’s relationship with the business community is in tatters.
Following Trump’s disastrous press conference in the wake of the domestic terrorist attacks in Charlottesville, VA, in which he put neo-Nazis on the same moral plane as counter-protesters, top US CEOs have distance themselves from him. Merck CEO Kenneth Frazier and Blackstone Chairman & CEO Stephen Schwarzman led departures and the disbanding of the White House Strategic and Policy Forum and a separate manufacturing council.
The meeting groups were largely symbolic, but their dissolvent represents a larger shift in the relationship between the Trump White House and the business community. The situation was not helped by POTUS’ public attacks on Frazier.
The lack of policy implementation and Trump’s rhetorical and behavioural missteps have not however, deterred the US’ overall upward economic trend.
Market volatility has been cut since the November 2016 election (see VIX above). In the same timeframe, the Dow Jones Industrial average has increased over 3,000 points since election day (peaking at 22,000 in early August) and according to the Bureau of Labor Statistics, the US unemployment rate (below) has fallen from 4.8 percent in January to 4.3 percent in August, a 16-year low.
BGA Outlook: Trump’s political saving grace may still reside within the stability of the US economy, but he will need the business community to help serve as advocates for his tax reform and regulatory agendas. Meanwhile his handling of the attacks in Charlottesville has further divided the nation along clear lines. The President’s frosty relationship with the Republican leadership in Congress has damaged his ability to get things done.
Furthermore, how much credit Trump can take for the present state of the economy is debatable. Currently only 30 percent of Americans feel the US is headed in the right direction, according to Gallup.
- Late September: NAFTA negotiations (3rd round)
- September 30: End of the US fiscal year
- October (TBD): NAFTA negotiations (4th round)
- October 13-15: 2017 IMF/World Bank Annual Meeting
NAFTA & Trade
A major Trump campaign promise on trade was the elimination of NAFTA. Often deemed by candidate Trump as “the worst trade deal in history”, his strategy has slightly changed at the behest of his Agriculture Secretary Sonny Perdue and additional pro-trade officials in his administration including Treasury Secretary Mnuchin and Commerce Secretary Wilbur Ross. Instead of ripping NAFTA completely to shreds, he, along with Mexico’s President Enrique Peña Nieto and Canada’s Prime Minister Justin Trudeau have agreed to renegotiate the nearly 23-year-old trade deal through a breakneck pace of four negotiating rounds expected to conclude by the end of the year.
Last month, officials from the US, Mexico, and Canada met in Washington for the opening round and again in September in Mexico City. Trade Provisional Authority (TPA) passed in the US Senate in 2015 requires enhanced consultations with Members of Congress and stakeholders unlike any witnessed in prior U.S. trade negotiations.
The US delegation has been steadfast in making bilateral trade deficit reduction its focal point. The US currently has trade deficits of USD 60 billion and USD 11 billion with Mexico and Canada, respectively. This is the first time a US Trade Representative has tied deficit reduction as a negotiation condition.
US Trade deficits with largest global economies and NAFTA partners (in USD): (US Census data, for goods, not services)
- China: 347 billion
- Japan: 69 billion
- Germany: 65 billion
- Mexico: 63 billion
- India: 24 billion
- Canada: 11 billion
- UK: 4.25 billion
In other US trade policy, President Trump withdrew the US from the Trans-Pacific Partnership (TPP) 48 hours after his inauguration, following through on another key campaign promise. The US’ absence from the 12-nation trade pact is already shifting the global trade landscape.
Japan, the US’ once closest partner in TPP, agreed to a mutual bilateral trade deal with the European Union in July. Although negotiations between Japan and the EU were launched as far back as March 2013, Trump’s decision placed a greater sense of urgency for the deal to get done.
Japan’s wariness of China as a standard bearer for trade not only throughout Asia, but also globally, is an added motivator for Tokyo as well. Another puzzling move is the president’s consideration of breaking its free trade agreement with South Korea (KORUS) as North Korea further develops its nuclear arsenal and China’s continued economic assertion in the region.
Trump’s approach to trade with China has been to take a tough line. Although Steve Bannon, the key advocate in the West Wing for a tough position on China has now departed, but don’t expect the administration to let up anytime soon.
BGA Outlook: Between now and when the fourth and final round of NAFTA negotiations is complete, key provisions investors should keep an eye on include:
- Digital trade in goods and services and cross-border data flows
- Regulation of State Owned Enterprises (SOEs)
- Anti-dumping & countervailing duties (“Chapter 19”)
- Trade deficits
- Currency manipulation and market-distorting practices.
- Rules of origin
NAFTA is in need of a facelift. The 1994 trade deal needs overhauls in modernizing business visas, new professional categories, and taking into account the digital economy.
Although POTUS has agreed to renegotiate NAFTA (for now), the US delegation has shown in the first round that it is willing to concede on very little. Multilateral trade agreements will not be the norm in the Trump administration and the bilateral approach the US is taking with Mexico and Canada is a clear indicator of this. NAFTA still could be scrapped if Trump has a change of heart and the US leaving the agreement would disrupt existing vital supply chains across the board, in the agriculture and automotive industries in particular and severely damage the direct relations between the three North American countries.
Trump will threaten tariffs, sanctions and import limits as has been seen in cases with Canada (over timber), Germany (automakers) and China (anti-dumping on steel). His approach to trade is consistent with his pre-presidency claims that the US is being “ripped-off” around the world. Towards both allies and adversaries, he has and will continue to push for tariffs on products, industries, and sectors in which he believes put the American worker at a disadvantage, regardless if its good policy or not.
On July 27th, the US Senate passed a new round of sanctions on Russia, 98-2. The bill also passed the House in similarly overwhelming fashion, 419-3. The bill was reluctantly signed by Trump as it requires him to seek congressional approval to amend or weekend existing sanctions and includes Iran and North Korea.
The sanctions specifically target Russia’s defense and intelligence sectors with the goal to make it more difficult for Moscow to export weapons, but the most controversial part for European investors are sanctions targeting Russia’s energy and oil sectors. These allow the US to place restrictions on companies working with Russia to develop energy export pipelines, directly effecting firms involved with the Nord Stream 2 pipeline between Russia and Germany, in particular.
In retaliation, Russia ordered the US to cut 755 diplomats from its staff as Vladimir Putin has all but given hope that US – Russia relations can be improved under the Trump administration.
The EU launched its own sanctions on companies doing business with Russia’s energy sector in 2014 after the annexation of Crimea, but Brussels wants confirmation from Washington that the sanctions do not negatively impact EU based energy companies. EU companies with stakes in the Nord Stream 2 pipeline are highly vulnerable and a very important pipeline for Germany.
BGA Outlook: EU officials are divided over the new round of US sanctions because of the disruption it could cause for the bloc’s energy and gas markets. Oil and gas imports from Russia are paramount to the broader EU economy. In 2015, nearly 26 percent of the EU’s imports of solid fuels and over 30 percent of crude oil imports came from Russia.
Tax ReformTo put it bluntly, tax reform appears dead on arrival. Despite the Trump administration’s best efforts to revive it while Congress was away during August recess, the fight appears to be in vain. POTUS’ alienation of Senators in his own party, the varying disagreements on a reform package, and the likely inability to capture the votes (in the US Senate) make it next to impossible for an overhaul of the US tax code to be passed by the end of the year.
Reforming the US tax policy is a tough task in itself, but it’s made tougher by POTUS’ eroding political capital. Key components of tax reform that investment analyst are looking for include the corporate tax rate, carried interest and the border adjustment tax (BAT).
The US has the third highest general top marginal corporate income tax rate in the world (38.92 percent). Only the UAE and Puerto Rico have higher rates. The White House is pushing for a 15 percent tax rate, while Republicans in Congress prefer a 20 percent rate. It remains to be seen if the two sides can meet in the middle. If they do, a legislative vehicle will need to be found to pass it at the chance comprehensive tax reform is not achieved.
A reoccurring point in the presidential debates was the tax on carried interest. Before August, the administration had been mum on carried interest, but Treasury Secretary Steve Mnuchin opened up on the topic this month, somewhat.
At an event with Senate Majority Leader Mitch McConnell (R-KY) in Louisville, KY, Mnuchin hinted that President Trump might keep the carried interest tax break for firms that create jobs, while eliminating it for hedge fund managers. Currently through the carried interest tax loophole, investment fund managers pay a tax rate of 20 percent, much lower than the top tax rate of ordinary income of 39.6 percent.
BAT or a proposed value added tax on imported goods or destination-based cash flow tax (DBCFT) was once considered a potential government revenue raiser, but it has been taken off the table by the Republican leadership in Congress.
Conventional wisdom by many political analysts is that tax reform does not have the votes in place to pass based on the Republican led executive and legislative branches to successfully pass legislation to repeal and replace the Affordable Care Act (Obamacare). But Speaker Paul Ryan is high on Congress’ chances due to procedure.
In their own words: “It gets a little weedy, but one of the challenges we had with health care reform, particularly in the Senate, is we had to use the Senate rules to write that bill…The entire tax reform bill can go into one bill through the House and the Senate. So procedurally it makes it much easier.” – Rep. Paul Ryan (R-WI), Speaker of the US House of Representatives
BGA Outlook: Despite Speaker Paul Ryan’s optimism on tax reform from a procedural standpoint, an agreement on a broad tax reform package is highly unlikely and the markets are managing their expectations as well. The best-case scenario is passage of a tax cut by year’s end as opposed to a full-scale overhaul of the US tax code.
Secretary Steve Mnuchin’s hint at a carried interest tax break is very important to note because he publicly admitted that hedge funds will not be covered under a carried interest tax cut, but according to the US Treasury Department, no decision has been made on private equity and “everything is on the table”. Of note regarding BAT, it may be tough to fund a possible corporate and tax reform program without it.
It was expected leading into August that the White House would take the lead on tax reform, but this approach has shifted, as now POTUS is looking to the relevant tax policy committees in Congress to draft the legislation following the recess.
Volker Rule: With Wall Street alumni in key positions within the Trump administration, expect major multinational US banks to try to work with the Treasury Department in rolling back some of the provisions of the Volker Rule.
If the financial industry didn’t believe they had many allies within the Obama administration, they have multiple now under Trump. The Volker Rule, a provision within the 2010 Dodd-Frank financial regulatory law was put in place to ban proprietary trading or banks making large trades with their own money. Securities trading is an important component of the business models of key investment banks and one of their main revenue streams. During the Obama years, major financial firms believed that the rule named for former US Fed Chairman Paul Volker, was extremely complex, burdensome and inhibited their market making abilities. With Trump’s promise to rollback Dodd-Frank, leading firms are hoping to
secure a review of Volker sooner than later.
Treasury: In June, the US Treasury Department released a 150-page report of their recommendations to overhaul the US financial regulatory framework. Their recommendations make up over 100 suggested changes. The recommendations include expanding the authority of the Financial Stability Oversight Committee (FSOC) “to play a larger role in the coordination and direction of regulatory and supervisory policies”, alter global capital standards, and to exempt financial institutions with USD 50 billion or in assets from stress tests.
The report recommendations also seek to encourage greater foreign investment in the US banking system to aid economic growth. The application of the TLAC rule to improve the resolvability of G-SIBs.
The proposals include many that have been championed by the industry for years, but have also been met with opposition from key lawmakers on Capitol Hill, including Sen. Elizabeth Warren (D-MA). The report is one of four that will be produced as future proposals are expected in regard to capital markets, derivatives, asset management, insurance, and clearing houses.
This process is significant as the Administration plans to implement this overhaul through the federal rulemaking process as opposed to congressional legislation.
Debt Ceiling & US Budget
Upon Congress’ return from August recess, they were left with the daunting task of not only having to pass the budget to prevent a partial shutdown of the US government, but also raise the US debt limit. The debt limit or ceiling is a limit that Congress imposes on how much debt the federal government can carry at any given time. When this ceiling or limit is reached, the U.S. Treasury cannot issue any more bills, bonds or notes.
In a September 6th Oval Office meeting with congressional leaders from both parties, President Trump stunned Senate Majority Leader Mitch McConnell and House Speaker Paul Ryan by agreeing with the Democrats’ plan to extend the funding of the US government through a continuing resolution and raising the debt limit for another three months until December. The Democrat’s plan combines Hurricane Harvey relief funding with extending the debt limit and funding the government. Senate Minority Leader Charles Schumer and House Minority Leader Nancy Pelosi represented the Democrats in the meeting.
Hurricane impact: Hurricane Harvey, the worst natural disaster in the US in a decade, was a major caveat as a relief funding bill will now be the vehicle used to attach the debt limit and budget extensions.
Before the deal was reached, Goldman Sachs Economics Research already lowered shutdown expectations from 50 percent to 35 percent. Their analysis that a shutdown of the US government in the midst of mobilization of federal relief efforts was a political risk hard to recover from. Expect further congressional relief funding for Hurricane Irma, which has already brought casualties as it approaches Florida.
BGA Outlook: Trump’s deal with the Democrats is a tentative one that will extend the debt limit and budge to December 15th, but Congress still must pass it. Both McConnell and Ryan are deeply upset with Trump’s move and more rank and file Republicans believe the president ceded all leverage to the Democrats without getting spending cuts in return. McConnell has vowed that he will not hold a vote to raise the debt ceiling for the rest of the year. Treasury will have to use “extraordinary measures” until an extension is passed. Economists are predicting that the US has until March 2018 to come up with a deal before seriously risking default.
Our Associates are closely monitoring developments so we can keep you updated on the political developments in Washington and their potential implications for financial markets. Contact us to schedule a call with our experts for more detailed views.