There's a big week ahead, and what President Trump tells Congress could be a huge deal

27-02-2017

There's a big week ahead, and what President Trump tells Congress could be a huge deal

Investors are hopeful that President Donald Trump will wrap some details around tax reform and other market-friendly programs when he speaks to Congress in the week ahead.

Expectations are high, but the likelihood is low that many real details on individual and corporate tax reform or fiscal stimulus will be forthcoming by Tuesday evening. However, the president did say on Feb. 9 that he would have a "phenomenal" tax plan just about now and some traders still hang on that hope.

The week will also be peppered with at least eight Fed appearances, most importantly Fed Chair Janet Yellen Friday, who speaks in Chicago and will be watched for any signals on interest rate hikes ahead of the March 14 meeting. There is also a heavy calendar of important economic reports, including the Fed's preferred inflation indicator — the personal consumption expenditure inflation data Wednesday. On Monday, durable goods are reported; revised fourth-quarter GDP is released Tuesday, and ISM manufacturing and vehicle sales are both expected Wednesday.

Earnings are winding down, but a few big retailers like Target and Costco report. Snap is expected to come to market this week with its big IPO, hoping to raise more than $3.5 billion in a deal that could value the Snap chat company at about $20 billion.

David Bianco, chief investment strategist for Deutsche Asset Management in the Americas, said the main focus will be on Trump's address to a joint session of Congress on Tuesday night. Since Trump was elected, the stock market has rallied hard, in big part on the promise of less taxes, less regulation and fiscal stimulus.

"I think we're already getting a hint of what's likely to come. I doubt we will get details, but what I'm looking for is their comfort in getting tax reform that's revenue neutral. I don't think he's going to address the border-adjusted tax. … No normal person knows what that is. … I doubt anything like that will get mentioned," he said. Bianco said he's concerned a border-adjusted tax could backfire, and the tax would be perceived as protectionist by trading partners who could retaliate.

How much policy detail comes from the president Tuesday has yet to be seen, but in general that's what the markets have been looking for even as the Dow sits at a record high.

"What we need for the markets to get to the next level is real solid policy, and Trump and his colleagues are talking about it, but we haven't really seen anything, and the likelihood of that is going down every day because of the cacophony of things you hear from the policymakers. For the markets, that's the biggest risk," said Oppenheimer Funds CIO Krishna Memani on CNBC.

The border-adjusted tax, or BAT, is at the crux of the debate in Washington — and on Wall Street— about how a meaningful corporate tax cut could be funded. Treasury Secretary Steven Mnuchin told CNBC Thursday that the administration sees both positives and negatives in the border-adjusted tax, which is essentially a destination tax.

It would tax all imports into the U.S. at a 20 percent rate but there would be no tax on exports. That is estimated to generate about $1 trillion over 10 years to help fund a reduction in the corporate tax rate to 20 percent from 35 percent.

Proponents say the tax would boost U.S. manufacturing jobs and level the playing field for U.S. business, encouraging them to bring home the corporate profits stashed overseas. Opponents say there may not be the 25 percent jump in the dollar that it would take to keep the tax from stinging U.S. consumers. The BAT is proposed as part of the House tax reform plan, but some senators oppose it as do retailers, who say it would force them to raise prices and basically put the tax on consumers. Industrial companies, like GE and Boeing favor it.

The president, in an interview Thursday, said he liked some kind of border tax, but he did not elaborate. "Just given the remarks from yesterday, it sounded like he's still in the pondering stage," said Michael Feroli, JPMorgan chief U.S. economist. Feroli said he believes the border-adjusted tax is too easily dismissed by its critics, who say the dollar would not adjust enough to prevent inflationary price pressures.

Feroli said he does believe the dollar would appreciate, and that it wouldn't burn emerging markets as some fear. "The dollar went up 25 percent in 2014 and 2015 and life went on. The expansion continued. Arguably, they're in a better position," said Feroli.

Without the BAT, Congress would be forced to leave some of the tax cut unfunded if it were to seek a 20 percent tax. "I don't think you want to start doing deficit finance stimulus at this point in the cycle," Feroli said. "The deficit would grow and you're not increasing efficiency and you're putting upward pressure on inflation."

How Trump spins this debate forward Tuesday is significant to markets even if he doesn't bring details with him. Mnuchin said the administration hopes to come up with a combined tax plan with Congress by August, after the Affordable Care Act is replaced.

"The bottom line is there's more potential downside than upside because we now have an early read from Mnuchin. If he's consistent with Mnuchin, fine, but what are we really learning," said George Goncalves, head of rate strategy at Nomura. "You've got to get the essence of how it's going to be implemented and the timing of it and really get more concrete examples, and if you don't, repeating what Mnuchin says is not going to be enough."

Treasury yields fell in the past week, in part on concerns about the French election. U.S. yields have been falling with German yields in safety trade, over fears that French candidate Marine Le Pen could win the presidential election and have France move off the euro.

But Goncalves said the 10-year Treasury could reflect what Trump says Tuesday. The 10-year yield was at 2.315 percent Friday, after finishing at 2.40 percent the week earlier.

"If it goes swimmingly, we're back at 2.45, 2.50. If it doesn't we'll be back at 2.10," he said. "I think it's got to be beyond the soft stuff. It's got to be tangible. It's got to be real," said Goncalves, noting the market will be looking for sequence and other details.

"The market is positioning for details," said Goncalves.

In the past week, stocks were mixed with the Dow and S&P 500 higher, and the Nasdaq lower. Treasury yields moved lower as investors both sought the safety of bonds, against risks in Europe due to the French election, and positioned for the end of the quarter. Gold also was in favor, with futures gaining about 1.5 percent this week and prices rose to a more than three month high.

The Dow closed up 11 at 20,821 Friday, its 11th record close in a row and the longest such streak since 1987, when there were 12 back-to-back record closes in the first 13 days of the year. The S&P 500 closed at 2,367, up 0.7 percent for the week, and Nasdaq was 0.1 percent for the week at 5,845.

Goncalves said he doesn't expect much from the parade of Fed speakers, even though Yellen and others have recently stressed the Fed could raise rates in March. The market doubts it, and most economists see June as more likely.

Feroli has said May is possible timing for a rate hike because of a recent pickup in CPI inflation. He's looking for PCE inflation to rise to 1.8 percent year-over-year from 1.7 percent in December.

"I doubt [Yellen will] change her tone much," said Feroli. "She's going to obviously talk about the outlook and I think she'll sound relatively upbeat and avoid talking about fiscal policy and say the labor market is almost where they want it to be."