HIGHLIGHTS OF THE WEEK
- With little to digest on the data front, attention was devoted to political developments this week. Stock markets remained upbeat through Wednesday, given optimistic expectations on tax reform, supportive earnings reports and gains among energy stocks.
- However, market sentiment turned down thereafter, as developments on tax reform failed to meet expectations, given key differences between the House bill and the newly-released Senate bill.
- While tax reform will remain top of mind in the days ahead, a number of important data releases next week will help tilt the narrative back toward economic fundamentals, with emphasis placed on the upcoming CPI report.
Tax Bills: When Two Is Not Better Than One
This week was exceptionally quiet in terms of economic data. There were no primary reports released and second-tiers did little to spur market action. On that front, JOLTS job openings and weekly jobless claims saw little change, while consumer sentiment (U. of Michigan) pulled back in early November but remained upbeat at 97.8 – a level marking the second-highest reading this year. With little else to digest on the data front, attention was devoted to political developments.
Markets remained upbeat through midweek, given optimistic expectations on tax reform, supportive earnings reports and gains among energy stocks. The latter were buoyed by a surge in crude oil prices, with rising geopolitical uncertainty in the Middle East, particularly in Saudi Arabia, being the main catalyst behind the move (Chart 1). Global demand has been strong and OPEC discipline is expected to continue, but the risks for oil prices are skewed to the downside as non-OPEC production is on the rise, particularly U.S. shale. The EIA reported that U.S. production reached 9.62 million (B/D) last week, which is at the top range of historical highs.
Market sentiment followed a more downbeat tone later in the week, as developments on tax reform, which appeared to overshadow headlines from the President’s Asia trip, failed to meet expectations. While the Ways and Means Committee advanced the House bill on Thursday, preparing for a vote by the full House next week, the Senate released its own version of the bill, with preliminary reporting pointing to some key differences among the plans. For instance, the Senate bill retains the current seven-bracket income tax structure with a new top rate of 38.5% as opposed to the reduced four-bracket structure in the House bill, it doubles the estate tax exemption but does not eliminate it after 2024, and it eliminates state and local tax deductions (SALT) without keeping a 10k deduction on property tax. Moreover, the Senate bill would delay corporate tax cuts to 2019 as opposed to implementing them in 2018, and takes a different approach on pass-through taxation, creating a new 17.4% deduction, as opposed to lowering the rate to 25% as in the House bill.
In short, there are enough differences between the two bills to make immediate passage less likely. Much rides on tax reform, with expectations for major change being one of the main supporting factors behind the impressive post-election gains in stock markets (Chart 2). As such, the delay is likely to weigh on near-term sentiment, with prospects for a later introduction of corporate tax cuts of particular concern to investors.
Tax reform is likely to remain top of mind in the days ahead, but a number of important data releases next week will help tilt the narrative back toward economic fundamentals. Hurricane-related volatility should begin to taper off in upcoming reports, supporting the Fed’s decision-making process. With the economy still on a solid course and the labor market tightening further, we remain of the view that the Fed will hike rates once more by year’s end. But, this will require some cooperation from inflation metrics, with the emphasis placed on next week’s CPI report.
Admir Kolaj, Economist
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