Have markets removed too much of the Trump trade? September will be critical

US Debt ceiling – needs to be raised by 29 September 2017

With the Trump Presidency entering its eighth month and the failure to repeal and replace Obamacare highlighting the legislative inexperience of the current White House, financial markets have largely removed any hope of expansionary policies from market pricing. Attention has now turned to the packed legislative agenda waiting for Congress in September and if this can be dealt with smoothly. This begs the questions have markets now gone too far? Is there any upside from fiscal expansion policies priced in? Alternatively given the packed legislative agenda, and previous issues passing legislation around the debt ceiling, are there some downside risks that markets are ignoring?

Following Donald Trump’s election the US Dollar Spot Index rallied peaking in late December 2016 on hopes of a lift in potential economic growth from significant tax reform and a $US1trn infrastructure spending package. Since then, the US Dollar more than retraced this gain. This has been driven by a combination of persistent low inflation, a lower interest rate path priced in for the Federal Reserve as well as the unwind of the Trump trade.

Bond yields have also removed some of the move to higher yields post Trump’s election while the exception has been the US equity market. Much of this has been driven by improving company earnings and an improving global economy with a stable macroeconomic backdrop, rather than expectations around Trump’s potential expansionary policies. Yet there is still likely upside potential if corporate tax rates do get cut.

So what are the key legislative actions required in September?

1. Debt ceiling

Treasury Secretary Steven Mnuchin has stated that an increase (or suspension) of the debt ceiling will need to be passed by September 29. Since the current debt limit of $US19.8trillion was reinstated on 15 March 2017 (after being suspended since October 2015) the Treasury have used extraordinary measures of funding, but they will likely run out of these measures by early October with social security and coupon payments due. With 60 votes needed to pass the debt ceiling bill in the Senate and the Republicans only holding 52 seats, at least 8 Democrats will be needed. There have been some occasions over recent years where the increase in debt ceiling has become a highly politicised issue and there are risks we could see some brinkmanship occur again. Partisanship politics have worsened since the Republicans failed in their bid to repeal and replace Obamacare, both between parties and between themselves. However despite some challenges in passing this bill the most likely outcome will be for an increase or suspension of the ceiling as President Trump and Congressional Republicans don’t want to be blamed for government default.

Source: Bloomberg. Data to 31 July 2017

2. Spending Bill
The second crucial piece of legislation that will need to be passed is a new authorization for Federal government spending. This is required from 1 October 2017 to avoid a government shutdown. The last spending bill was passed on 5 May 2017 after several weeks of negotiations and could become contentious depending on the willingness of President Trump to demand funding for his key policies including the border wall with Mexico and a significant increase in Defence spending at the expense of key domestic programs. As we have seen in recent spending bills there is a real possibility that only a short term spending bill will be approved, given once again 60 votes are needed to pass this legislation, requiring some Democratic support. 

3. Fiscal year 2018 Budget and tax reform
The passing of a budget resolution for fiscal year 2018 is a necessary precursor to passing tax reform legislation and will need to happen in October or November 2017. This will then allow tax legislation to be written and passed sometime in early 2018, well ahead of the mid-term elections in November 2018. Despite recent performance and record low approval ratings for President Trump the Republican Party could perversely increase their power in the Senate as more Democrats are up for re-election in swing states in 2018.
Importantly the passing of a Budget bill will allow any taxation changes (a key Republican election pledge) to be passed by only 51 votes in the Senate rather than 60 votes, under the reconciliation process. However the challenges are immense for tax reform. This includes division in the Republican Party over goals for tax reform and to ensure any changes do not increase the deficit outside of the 10 year budget window, a requirement for using the reconciliation process. Given the challenges and political realities of tax reform, particularly the deficit hawks and right-flank conservatives of the Freedom Caucus, reform could turn into simple and temporary corporate/personal tax cuts expiring after 10 years. 
However with Trump’s criticism rising over the time taken for legislative achievements, and his personal criticism of Senate Majority leader Mitch McConnell in recent weeks, the Republican Party may struggle to nurture a consensus. This could see a below par tax reform bill, less potential growth uplift and raises the risk of brinkmanship on the debt ceiling and spending resolution which could lift market volatility instead of boosting markets into the new year.