On the same day that the Dow Jones industrial average topped 21,000, reaching a new intraday and closing record, Vincent Reinhart, chief economist of Standish Mellon Asset Management, told a luncheon gathering focused on President Trump’s first 100 days in office that the “market pricing in too much too soon … expecting too much out of DC. The policy process always takes longer.”
He should know. Reinhart spent more than 20 years in Washington, working for the Federal Reserve in various positions including director of its monetary affairs division and economist of its policymaking Federal Open Market Committee (FOMC) before becoming resident scholar at the American Enterprise Institute and then chief economist at Morgan Stanley.
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Underpinning the recent rally in the stock market are expectations for corporate and personal income tax cuts as well as repeal or loosening of federal regulations, seen as helping to drive economic growth.
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But while some efforts at deregulation are already underway – think of the proposed delay of the Labor Department’s fiduciary rule and the introduction of a House bill giving the White House, through the Office of Management and Budget, the power to reject regulatory plans of federal agencies – tax reform is not.
“Until an Obamacare replacement is clear, tax reform will stay on the back burner,” wrote Greg Valliere, chief global strategist at Horizon Investments, in a recent edition of his Capitol Notes.
Trump said as much Monday before the National Governors Association: “We have to do health care before we do the tax cut.” He also said that tax reform is a “tiny ant” compared to the replacement of Obamacare.
Not only will investors have to wait for tax reform, but the changes may not be as expansive as they would like.
At the luncheon sponsored by BNY Mellon Investment Management, Sinead Colton, head of investment strategy at Mellon Capital, said that one of the biggest risks U.S. markets is “disappointment” that the corporate tax reform may not be as significant as expected and personal tax cuts may be fewer in number.
But tax reform will be pursued, said Reinhart. “Congressional leaders see a once-in-a-lifetime chance to make changes to radically reframe a terribly inefficient corporate and personal tax system.” He also expects more movement on deregulation – a “nibble on edges of Dodd-Frank” – though he mentioned Trump’s surprising “silence” about Dodd-Frank in his first speech to Congress on Tuesday.
No matter. “More significant changes will be done at the agency level, tweaking regulations and enforcing them,” said Reinhart. “Who enforces regulations matter more than who writes them.”
Deregulation could also have some unintended effects.
Jamie Lewin, managing director and head of product strategy at BNY Mellon Investment Management, said climate change denials, leading to less environmental regulation, could ironically create more demand for environmental, social and governance investments rather than crowd them out.
Reinhart agreed, noting that such investment are “client driven.”
Despite the administration’s focus on fiscal rather than monetary policy, it is expected to have a big impact on the latter. “Trump will be able to reshape Fed policy,” said Reinhart, who expects the Federal Reserve will become more hawkish.
There are currently three open seats on its Board of Governors, which could grow to five by this time next year, said Reinhart.
In the meantime, the odds of a Fed rate hike in March have risen to around 80%. New York Fed President William Dudley, San Francisco Fed President John Williams and Fed Governor Lael Brainard have all indicated as much in speeches this week.
Financial markets may get even more indications about the Fed’s next move when Fed Chair Janet Yellen and Vice Chair Stanley Fischer speak Friday.
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