- The consensus remains short USD, with net positions at multi-year lows
- Markets continue to be skeptical of Trump, but expectations are at bearish extremes
- Even a good draft of the final tax plan can power the dollar forward given low expectations
Despite big promises and even higher expectations, Trump’s ability to deliver has been a question mark for markets for most of 2017. Following the failure to reform healthcare in the first half of this year, markets went bearish on Trump and his broader agenda of tax cuts and fiscal spending. Inflation expectations, initially driven by Trump's pro-growth agenda, fell sharply alongside the value of the dollar. Today, speculators hold large short positions against the US dollar while remaining significantly long Australian dollars, Canadian dollars, and euros in futures markets. This is shown in the table below:
The consensus continues to dislike the dollar
After going short earlier in July, the consensus has been mostly right as the dollar has continued to weaken. But today’s large short position is dangerous, as the bar for expectations has seldom been lower.
Skepticism at extremes, and the bar for surpassing expectations remains very low
Last night, Trump raised hopes for both lawmakers and markets by saying they should expect a “very, very powerful document” that would deliver big tax cuts, especially for the middle class. Leaks to the media suggest that the administration is looking to cut corporate income tax down to 20%, while collapsing today’s seven personal income tax brackets down to three or four. The leaks make it clear that the White House is working on a complete overhaul of America’s tax code, as opposed to simple tweaks. The US tax code has not been significantly overhauled since Ronald Reagan’s administration in 1986.
After Republicans failed, again, to reform Obamacare this month, markets are increasingly skeptical that Trump will be able to make tax reform a reality. Given the very low bar today, we would argue that even a tax plan that falls far short of a full overhaul would be sufficient to change the trajectory of expectations.
An unconventional President brings unconventional results
Unlike previous Republican presidents who have typically worked closely with party leaders, Trump is more resourceful when looking for ways to get to the finish line. His solution to the debt ceiling issue, siding with senior Democrats, was a good example of his ability to get things done unconventionally. Unlike beltway insiders, Trump has little to lose from siding with his party’s opponents.
While convention would expect a fully fleshed out tax policy with most details accounted for, Trump is likely to leave out many details in order to please a wide range of constituents. By doing so, the White House will have drafted a tax plan that has something for everyone – and one much more likely to get through a bipartisan process in Congress.
A breather at a minimum, and potentially a larger move up
The US dollar index has gained for three weeks in a row today, and at a minimum we expect the dollar to take a breather from its bear market this year. Based on a wide range of indicators, including speculator sentiment and oscillators, the dollar remains in oversold territory and is due for a rebound.
In the longer term, and once the current administration is able to pass healthcare and tax reforms, we expect a larger move up in the dollar as markets gain confidence in Trump’s unconventional ways of achieving his means. Despite the initial reaction following today’s announcement, we think the tax plans should bode well for the dollar.