Let's revisit the first Trump administration for a moment. His first major piece of legislation, which passed in December 2017, was the tax cuts, which cut the corporate rate to 21% from 35%. The tariffs didn't begin until 2018, and were narrowly targeted at first (washing machines, solar panels, steel and aluminum). Broad tariffs against China didn't begin until later that summer.
The timing of this turns out to have been pretty important, in retrospect. As Matthew Shay of the National Retail Federation and other guests have told us, the lower corporate tax rate helped blunt the impact of tariffs when they actually started to hit. And while the headline numbers were large--25% tariffs--they didn't apply to all Chinese imports. As a result, our effective tariff rate on China has only increased from 3% to about 11% as of September, even with the Biden administration's added levies.
All of this is why Wall Street has largely shrugged off the tariff talk from Trump so far. It's not to say they don't take it seriously, and don't view it as a larger risk to the economy this year. It's that it all comes down to the exact timing and details of how his plans play out.
Case in point: this morning's Washington Post story that the president-elect's aides are exploring tariffs that would be "universal" in that they apply to every country, but would only cover "critical" imports. These could include the defense supply chain (steel, iron, aluminum, copper); medical industries (syringes, vials, etc.); and energy production (batteries, rare earths). Obviously, that would be far less impactful to the broad economy.
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And it turns out that persistent inflation may be one reason the president-elect would consider this pared-back approach. The Fed, recall, upset markets last month when it forecasted only two rate cuts this year, down from four. Core CPI is still expected to be over 3% when the December figures come in next week. Tariffs could add upward price pressure in the near term, even if they prove more contractionary in the long run, as they did last time. (The Fed, remember, was cutting interest rates by 2019.)
So while the sands may shifting on the tariff front--emphasis on "may"--in a way that is bolstering markets this morning, there is much less help coming on the tax front than last time. The best-case scenario is that corporate tax rates simply stay the same (they are currently set to expire at year-end). And even that fight will be tricky and complicated with the Republicans' extremely slim majority in Congress.
Last night, Trump tweeted that he wants the tax cut extension to be included in "one powerful Bill" that Congress will have to shove through this year with border and energy reform included. This morning, he told Hugh Hewitt that he would "prefer one," but was open to "whatever needs to be done," if that means two bills, "as long as we get something passed as quickly as possible."
Money Report
The worst-case scenario for markets would be broad tariffs followed by a sharp hike in corporate tax rates. The less likely that seems, the better markets are likely to do in the first year of his second administration.
See you at 1 p.m!
Kelly
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