The Daily Prophet: Tax Plan Lands on Wall Street With a Thud

Connecting the dots in global markets.

For all the hype during the run-up to the release of the U.S. House Republicans' tax plan, the reaction in the financial markets was, to put it gently, less than euphoric. Major stock indexes spent the day mostly lower before ending little changed, which suggests the news was already priced into equities. And if that's the case, investors should be very nervous.

Stocks jumped this year, pushing the S&P 500 Index's price-to-earnings ratio above 20, in part on the expectation that taxes for companies would be cut. On that front, the Republicans delivered, proposing that the corporate rate be reduced to 20 percent from 35 percent. Going forward, and assuming the tax plan becomes law, that means companies will have to deliver on hefty earnings growth expectations to justify current valuations. There's little margin for error, with Wall Street forecasting an ambitious 12 percent increase in earnings next year. "There's nothing there that exceeded expectations," Steven Englander, the head of research and strategy at Rafiki Capital Management, told Bloomberg News's Ye Xie in reference to the tax plan. "It's the minimum the market expected, not something that the market can get more excited about it."

Still, this plan is just a starting point and is likely to be heavily revised as it works its way through Congress. The bill ran into opposition almost immediately, according to Bloomberg News. The National Association of Realtors said a measure to cap the mortgage-interest deduction on new home sales at $500,000 "appears to confirm many of our biggest concerns." The president of a national small-business group said the bill "leaves too many small businesses behind."

BOND, DOLLAR TRADERS NOT OPTIMISTIC
Perhaps better gauges of the sentiment toward the tax bill are the bond and currency markets, where Treasuries jumped and the dollar slumped. If investors really expected the plan to breeze through Congress and be passed this year, then the opposite should have taken place. Instead, lower yields and a weaker dollar suggest traders expect the bill to provide little benefit to the economy. The action also indicates that maybe bond investors assign little chances of the bill becoming law, because if it did it would only add to the budget deficit, resulting in more supply for Treasuries as the government sought to raise money to make up for lost revenue. "The Tax Reform proposal put forward by the House of Representatives is in line with our expectation that tax cuts are unlikely to be offset by equivalent cuts to spending," Sarah Carlson, a senior vice president at Moody's Investors Service, said in a note. "This would put upward pressure on the federal budget deficit and debt." Credit Suisse's global head of foreign-exchange strategy, Shahab Jalinoos, told Bloomberg News's Alexandria Arnold that there's no indication in the proposal on how to resolve tensions between Republicans who want to cut taxes and those who are focused on balanced budgets, setting the stage for a showdown.

POUND POUNDED
If you were long sterling going into the Bank of England monetary policy meeting, you have our condolences. Usually when a central bank raises interest rates, as the BOE did Thursday for the first time in a decade, that nation's currency tends to appreciate as foreign investors seek to take advantage of the higher yields that result. But sterling promptly tanked, with the Bloomberg Pound Index falling the most since October 2016. Moreover, five-year gilt yields tumbled. Behind the moves were some very dovish comments from BOE Governor Mark Carney, who made clear the central bank has no intention of raising rates further anytime soon. That means currency traders will go back to focusing on familiar themes such as the endless headlines on Brexit and politics, according to Bloomberg News. That wasn't the case in September when the pound staged a big rally after minutes of that month’s BOE meeting indicated the central bank was looking to raise rates soon. From then until Thursday, traders ignored virtually every headline related to Brexit and U.K. politics, treating such news as background noise. "Future swings in sterling or gilts will be sensitive to political developments," said Nicholas Gartside, chief investment officer for fixed income at JPMorgan Asset Management.

ONE TREND POWELL CAN'T FIX 
Jerome Powell will soon take over as head of the U.S. Federal Reserve, among the most powerful institutions in the world. In his new role as Fed chair, Powell will get to decide the cost of money. But as he already knows, being a Fed official is a thankless job. As Deutsche Bank economist Torsten Slok points out, the central bank is constantly being criticized by politicians, by market participants and sometimes even by other central bankers and institutions such as the International Monetary Fund and the Bank for International Settlements, even though the Fed arguably saved the world in 2008-2009 from the worst financial crisis since the Great Depression. Yes, the economic recovery has been weak, but Slok says the reality is that the healing in housing, banking and consumer balance sheets took a long time and it is not yet clear whether central banks should have done more quantitative easing to generate a faster recovery. Critics of QE say the program has only inflated the prices of assets such as stocks and bonds to the benefit of the wealthy at the expense of the poor. To Slok, part of the blame for income and wealth inequality should go to governments and their lack of fiscal stimulus. That's not something Powell can fix.

DAIRY MARKET TURNS SOUR
If you've been fretting about high butter prices, relief is on the way. Global dairy prices slumped 4.2 percent in October, the most since March 2016 and a drop from a three-year high, according to Bloomberg News's Agnieszka de Sousa. The United Nations Food and Agriculture Organization said Thursday that butter and whole-milk powder prices dipped as importers held out for new supplies from Oceania, while lower demand and ample stockpiles in the European Union pushed skimmed-milk powder lower. Even with the declines in October, dairy costs are still up 12 percent this year after global exporters in the EU, the U.S. and New Zealand curbed their output. Rising demand helped send butter prices to a record this year, leading to a shortage of the staple in France, the biggest per-capita consumer. The decline in dairy prices, along with vegetable oils, meat and sugar, led to the FAO's overall food-price index falling 1.3 percent in October.

TEA LEAVES
What a week it's been, and it's not over yet. Friday brings the all-important U.S. monthly jobs report. Surveys of economists show that employers probably added 312,000 workers in October, after two hurricanes helped reduce payrolls by 33,000 a month earlier in the first decline since 2010, according to Bloomberg News' Shobhana Chandra. Don't be surprised if a number closer to 400,000 is reported, according to Bloomberg Intelligence. The so-called whisper number is more like 277,000, which means there could be some notable volatility in markets no matter where the number lands. The widely watched average hourly earnings figure, which jumped to 0.5 percent in October, probably eased back to the 0.2 percent level, estimates suggest.

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