Bill on taxes and shrinkage torment –

Bill on taxes and shrinkage torment


The tax law score from the Congressional Budget Office (CBO) was published at 8:49 PM Friday night, and this link will take you to it. The title of this one-page document is cumbersome: "Summary of the effects of the deficit of a bill to provide reconciliation in accordance with the concurrent Resolution on the budget for fiscal year 2018, as presented by the Senate on 1 December, 2017. "

The numbers here are critically important although there may be some additional financial adjustments, since the Senate debate ended in the early hours of Saturday morning and since the text of the Senate version contains handwritten notes on the legislation that has not been read (and much less noted) by CBO. We note that some commentators believe that the notes are not even readable.

Anyway, this is our political system, like it or not. As Churchill observed in the House of Commons in 1947, "In fact it has been said that democracy is the worst form of government, except for all the other forms that have been tried from time to time …" Sir Winston He originated the line, but he made it famous. Its origin is subject to debate. Personally I verified that fact with the main archivist of the Churchill Library.

The Senate version of the tax bill (whatever it is) and the House version (which we have been able to read) will now go to a conference for the next round in this political air combat. Our opinion is that there will be a final tax bill and that Trump will sign it regardless of how the final bill looks.

We will leave aside the comments on the detailed tax changes, since they have already been discussed and are not final until we get a conference version from the House of Representatives.

Let's get to the deficit.

We are using the CBO score detailed in the link as a guide. Remember that the budget and deficit projections have a wide margin of error. They are based on many badumptions. The only thing we really know about these badumptions is that they are wrong the day you do them. The idea is to treat the subject correctly and try to get closer to what the final numbers will be.

These are the topics.

The additional federal deficit that is expected to occur as a result of this tax. it is added to the baseline of projected deficits. Therefore, we can combine the baseline we know with the CBO score we see, and that brings us to an estimate of the total deficit over the next ten years. We know that the interest component and other components (such as transfer payments) are set as legal obligations and are not discretionary. The United States will pay interest on its debt no matter what the rate. We can project that rate, but we are guessing because we do not know what rates the Federal Reserve will establish during the next decade.

We do not even know what the rates will be next year. We can only make conjectures about that. The only thing we know about long-term interest rate forecasts is that they have proven to be consistently wrong.

We hope that the cumulative effect of these changes in the tax bill will bring the deficit to 100% of the nation's GDP in the "years". What a year that happens is irrelevant! It is the trend that counts. And that trend has increased and will accelerate after the tax bill pbades and begins to be introduced progressively.

In 2018, the impact will be small and the markets will not feel it significantly. By 2019, the impact will begin to increase, and markets could be absorbing $ 700-800 billion of new issuances of incremental federal debt at the same time that the Federal Reserve disburses hundreds of billions in holdings guaranteed by the federal government while the Fed also reduces its overall balance. Keep in mind that the Fed will not sell: it simply will not buy as much replacement debt when maturities occur.

We have enough information from the official testimony of the Fed and the Fed releases to estimate that the Fed will reduce its balance sheet by a total of approximately $ 1 trillion or more. This process will take years. We have a projected contraction path that the Fed has revealed. But we also know that the Fed does not intend to shock or derail the economy or the markets, so there may be some flexibility in the Fed's path if a crisis develops.

We want to mint a new term. We hope that the contraction path is not smooth. The roads for contraction are rarely. So we expect to see a "contraction tantrum". That tantrum can remind us (and the markets) of the "diminishing tantrum" that occurred when Fed Chairman Bernanke first mentioned a declining policy half a decade ago.

The contraction tantrum may burst without market preparation and reflect a global change in sentiment. We believe that the reaction will coincide with the changes that are approaching as the European Central Bank begins to decrease to zero from negative rates. It is easy to project a 10-year German government bond trade at a positive interest rate close to 1%, while a 10-year US Treasury note is quoted at a positive interest rate of 3%. Readers can do the rest of the mathematical operations to create forward rate curves, a calculation we do every day in Cumberland.

Keep in mind that these are level estimates. They badume that low inflation stays with us; they involve gradualism on the part of the main central banks; and badume a baseline of no external shocks such as North Korea or an Ebola / Zika outbreak or a recession and / or a restriction of consumer demand and consumer spending and / or the abruptly contractionary impacts of changes in US trade policy. 19659015] Market dynamics alone will push interest rates up. Other factors can exacerbate the direction and accelerate the change of trend.


"Oh," wrote Willy Shakespeare in Hamlet's immortal soliloquy, "there's the problem."

The numbers we see projected are on the way to being gradual. A 3% note from the US Treasury. UU It may not arrive for another 2-3-4 years. That is the benign scenario. But that projection has no margin for errors. And it does not have a "expectations" component. And that's where we find "the problem". How far in advance will prices start to be priced in these changes, and what additional amount of interest premiums will buyers of bonds demand for an uncertain and evolving risk? Nobody knows.

In summary …

There will be a final tax bill. There will be a growing deficit that will finally push higher interest rates. The contraction of the Fed's balance exacerbates this transition.

Finally, there is probably a "shrink tantrum". When, and how serious a tantrum will be, we still can not know.

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