The Market Today

Competing Tax Plans Illustrate Difficulties Ahead

by Craig Dismuke, Dudley Carter

Today’s Calendar- Consumer Confidence; Veterans Day:  The only economic report on the calendar today is the University of Michigan’s Consumer Confidence Index.  The measure is expected to show a slight tick higher and remain at a very strong level.  Tomorrow will mark the annual remembrance of Veterans Day.  Congress officially established November 11 as a day of remembrance following the end of World War I. This day was made a legal holiday in 1938 called Armistice Day, honoring Veterans of WWI. Following WWII, in 1954, Congress changed the holiday to Veteran’s Day to honor American Veterans of all wars. To all American Veterans, thank you from all of us for your service to this country.


Senate Republicans Release Materially Different Tax Proposal:  Senate Republicans released their version of a tax plan yesterday and it contained some similarities to the House plan but some material differences.  The Senate plan continues to apotheosize the idea of cutting the corporate tax rate to 20%.  The rate cut for corporations would not begin until 2019 according to the Senate version.  The repeal of many of the deductions, credits, and exemptions are likely to still be included in the Senate plan.  The pass-through rate, capped at 25% in the House plan, would be allowed to go above 30%.  On the individual side, the Senate plan contains seven brackets instead of four with a top rate of 38.5% (39.6% in the House plan).  State and local taxes would not be deductible in the Senate plan, not even the $10k property tax deduction the House plan. Mortgage interest is allowed to be deducted, not reducing the mortgage principal amount from $1,000,000 to $500,000.  The standard deduction is double, personal exemption is eliminated, and the child tax credit would be increased to $1,650 (versus $1,600 in the House plan).  While the differences appear small, there are some fundamental challenges.  The obstacles to passage are becoming increasingly obvious.


The Money Challenge for Tax Reform:  Underscoring the difficulties we see ahead for this process, whatever tax plan eventually emerges can only increase the deficit by $1.5 trillion over the next 10-years according to the budget instructions already written by Congress.  Under the House plan, the cost of reducing the corporate tax rate to 20% would be $1.465 trillion over the next 10 years.  Meanwhile, the reduction of exemptions, deductions, and credits would increase revenues cumulatively by approximately $600 billion (according to the Joint Committee on Taxation).  This brings the bill for corporate tax reform to approximately $865 billion, leaving $635 billion available for net tax cuts for the individual code.  The House plan to reduce the tax brackets to four would cost $1.5 trillion alone.  This is why so many deductions or credits would necessarily need to be scaled back or eliminated to bring the overall price of the tax plan back down to $1.5 trillion.


Overnight Activity – Yields Rise Overnight as Global Equities Continue to Stumble: Yesterday’s broad-based weakness for U.S. equities bled over into global trading Friday where there have been only a handful of national indices improve. Shares tracked by China’s CSI 300 gained 0.88% while Japan’s Nikkei wavered 0.70% and the Stoxx Europe 600 edged lower 0.18% through midday. China’s upside surprise against the more cautious global backdrop was likely impacted by news the country would be easing restrictions on certain types of local investments by foreign companies. Friday’s overall negativity may not turn around in U.S. trading based on current futures positioning. Contracts on the Dow are off 0.15% and those on the S&P are 0.30% lower. Sovereign yields are higher except on the European periphery. The Spanish 10-year yield is lower by 1.7 bps while Germany’s has increased 2.0 bps and the U.K.’s has risen by a larger 5.3 bps. The U.K.’s outsized increase followed stronger-than-expected industrial production and rolling monthly GDP reports. Treasury yields are up as well with the 2-year +1.7 bps, the 5-year +2.3 bps, and the 10-year yield +3.0 bps. The overnight increase for the 10-year yield busted what would have been a match of the tightest weekly yield range since 1998. The Dollar remained weaker and at its lowest level since before the ECB’s October 26th policy announcement sank the Euro.


Yesterday’s Trading Activity – U.S. Assets Fluctuated as Markets Digested Details of Senate Tax Plan, House Passed its Version Through Committee: As early futures trading indicated, equities opened weak with tech companies leading losses. Even so, Treasury yields held their overnight rise for the first couple of hours of trading. That changed around 10:45 a.m. CT after reports indicated the Senate’s tax plan would delay cutting the corporate rate until 2019. As that headline trickled out, stocks extended their losses, yields gave up their gains, and the Dollar sank; all quickly moved to their daily lows. A perfect alignment between the Senate and House plans was never expected but the reports were the latest reminder that tax reform can be a divisive and heavy lift. Around noon, additional details from the Senate plan began to emerge and stocks and yields climbed back off their lows. Shortly after 2 p.m. CT, the full Senate plan was released and the House Ways and Means Committee approved their version. The House Committee’s plan will now be put to a vote in the full House. When the dust had settled, the Dow closed down 101 points (-0.43%) but had more than halved its day’s worst 253 point (-1.1%) decline. The S&P dropped fell 10 points (-0.38%) after earlier losing as many as 28 points (1.1%) earlier. While Treasury yields also moved about, the magnitude of the shifts was more subdued than in equity markets. Longer yields recovered while shorter yields remained near their daily lows. The 2-year ended down 1.2 (1.63%) while the 10-year yield rose 2.1 bps (2.34%)


November 2017 Bloomberg Survey of Economists: The November Bloomberg Survey of Economists shows few changes to the economic outlook, no changes to the Fed Funds projections, longer-maturity-yield expectations essentially unchanged, but a slightly higher rate path for short-maturity Treasuries. Click here to view the full survey and updated economic and interest rate forecasts.

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