Should we be worried about the burgeoning balance sheets of developed market central banks as the prospect of tapering comes into view?
Since the financial crisis, central banks have cut interest rates and bought bonds to boost economies around the world. This has boosted asset prices and, after a lagged effect, this appears to be passing through to the broader economy. At times the prospect of higher rates and a reduction in bond buying has concerned the financial markets, evidenced in 2013 with the so-called ‘taper tantrum’, when the prospect of less support from the Federal Reserve temporarily spooked markets. Since that time we have seen two rate rises in the US and more have been priced into the market for 2017. The US Federal Reserve has skilfully prepared markets for these rate rises and as a result equity markets have subsequently made new highs.
Providing other central banks manage their balance sheet and interest rate adjustments with the same care we should not be excessively concerned. The key to doing this is a gradual approach in response to stronger economic conditions, combined with preparing the market in advance. If the economic data is strong and the markets expect the balance sheet adjustments they can pass off with little impact on risk asset prices. The danger comes if we see another economic slowdown before any adjustments have been made; this would expose the lack of flexibility left in the central bank’s armoury. With signs of improving growth in many global economies we do not see this as an imminent threat for now.
What impact do you see from Trump’s proposed tax policies?
The long awaited tax policies proposed by President Trump this week are notable for the lack of detail, amounting to less than 250 words. For the most part, the proposal reflects Trump’s campaign rhetoric on the topic. It puts forward a reduction in the number of tax brackets from 7 to 3 and a cut in the top rate from 39.6% to 35%, though no detail is offered on what income levels these brackets will correspond to. Perhaps most significantly, the plan proposes a 15% corporate tax rate, a substantial drop from the current rate of 35%. Other components include a one-time repatriation tax, as was expected, and the repeal of a code which allows individuals to deduct state and local taxes from reported income.
The key concern surrounding the proposal is the cost. The document offered no insight into how the tax cuts would affect the large federal deficit. A rough analysis released by the Committee for a Responsible Federal Budget estimates Trump’s plan as costing $3 - 7 trillion. Treasury Secretary Mnuchin, has claimed that the tax plan would be self-financing from the rapid economic growth it would stimulate. Many commentators have disagreed.
The market was underwhelmed by the announcement. This appears to be an opening proposal as a negotiation position and as such, a smaller set of reforms is to be expected. As we have become accustomed to, there appears a disparity between what Trump says he will do and what he is able to do. It is doubtful that a significant increase in the US debt ceiling will be agreed upon and hence unlikely that these tax reforms will pass without substantial changes.
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