Rockin and Rollin USA.
So why the headline. Since Trump gained power equities have rallied and so too bonds after an initial major selloff. Much of Trump’s policies that should have flown under the radar unfortunately were on the radar but there is one policy that to date has flown under the radar and has the potential to have a massive impact on the way business in the USA operates in the future.
Forget about travel bans, forget about the latest round of Medicaid or the repeal of Obamacare that looks likely to through 22 million of insurance, this initiative is massive. Yet few are talking about the change and even fewer are writing about this change. The change is the removal of the deduction that companies get for the interest they pay. This is a massive change and has the potential to generate in excess of $1.5 trillion over a decade. “In 2015, U.S. businesses paid in all $1.3 trillion in gross interest.” (WSJ)
If as the Republicans propose the cost of doing businesses materially changes. Share buybacks, dividend increases through borrowings would cease. M&A activity would change where more equity is used alternatively we will more U.S. firms taking advantage of other countries tax codes where debt is deductible.
The U.S. firm would be allowed immediate deductions for investments in equipment and other assets. The policy is expected to accelerate and increase investment in capex, growth, worker productivity and R&D. If this belief in practice rings true then we could see a significant revival of U.S. business. The alternative is that we could see more offshoring as companies seek to use the tax shield provided in other countries.
Either way though the landscape will change. Debt will still remain as it still is cheaper than equity although the gap will close significantly. The skill in the deal will be in the allowable deductions. What happens when a firm buys land to develop or buys seed and fertilizer? What the bill is trying to remove is the distortion caused by the current tax system. For example, the marginal tax rate on an equity financed investment is 34.5%, for debt financing the investment is negative 5%. The changes will certainly affect banking and private equity but to what extent? Those changes will be a function of the changes that are implemented. In all probability, the tax deduction won’t be entirely removed but most likely will be watered down.
The U.S. economy is hinting at a slowdown. The durable goods orders were weaker than expected. Durable orders were down 1.1% and that sent a shockwave through the equity market, debt market and currency markets.
Bonds rallied to their low for 2017. The 10-year U.S. treasury closed at 2.135%. Bond investors remain pessimistic about the Trump administrations ability to reduce taxes and improve growth rates. Bond investors also appear to believe that inflation will remain benign especially as oil falls and remains low and some pharmaceuticals reduce in price. The European bond markets were relatively quiet with the UK 10-year benchmark closing at 1.006 rallying about 3 bp.
Equities were marginally up with the Dow up 0.07%, and the Nasdaq falling 0.29%. The S&P was steady up 0.03%.European shares fared well on the day after the Italians announced a clean-up of two ailing banks. The Stoxx 600 rose 0.4%. The activist investor Loeb’s investment in Nestle saw Nestle rally 4.3%.
The Bloomberg Dollar Spot Index was steady. As were the other majors.
The real fun and games were in commodities today. The gold market was where the action was today. On the London opening an order of approximately 20 tonnes hit the market and that caused gold at one point to fall $20. This was the lowest price in over six weeks. Gold fell at one point to $1,236.46 before closing 1,246.40. Gold after the fall rebounded $10 in a minute. The order was thought to be human error but in a world of automation it may well have been a program hunting shorts that repurchased after discovering no sellers had lined up in the selling orders.` WTI rose 0.9%.
The Aussie Market Today
Expect more of the same, soft to quiet equity markets and a slightly positive bond market. I expect to see continuing flows into the Aussie bond market and that should for the time being bolster the Aussie dollar.