#MacroMemo: Mar 27 - 31, 2017

This week’s #MacroMemo covers a wide range of hot topics including recent U.S. political setbacks, Canada’s #Budget2017, #Article50, and possibly peaking macroeconomic signals. I also preview Canadian monthly GDP and China’s PMIs. Enjoy!

U.S. political setbacks:

• The U.S. administration has suffered two setbacks over the past few weeks. The first was the failed effort to repeal Obamacare. The second was the spectre of a political scandal as the FBI hints of complicity between the Trump campaign and Russia.
• There is nothing stopping politicians from taking another crack at Obamacare at some future date, but a heavy legislative calendar and the inability of the Republican-dominated House to secure the necessary votes despite widespread loathing of the incumbent law has delayed it indefinitely.
• Meanwhile, the mounting toll of ousted and compromised officials over Russian allegations presents a further threat to the legislative agenda. While the outright removal of President Trump before the end of his term is far from an automatic proposition, it is admittedly conceivable depending on how the FBI investigation plays out. Betting websites put the odds of his early exit at between 45% and 55%. We assign a lower 35% probability. This scenario necessitates contemplation given the non-trivial odds and the fact that early Presidential departures have historically had a short-term negative effect on equities. That said, the policy contours of a hypothetical President Pence (tax cuts and small government without as much protectionism) could substantially ameliorate the market’s medium-term interpretation.
• All of this matters in its own right, but is also relevant as we look forward to the next waystation on the legislative agenda: tax reform. This is the big ticket item that the market has long anticipated. Its prospects are surely somewhat shabbier given the inability to rescind Obamacare and the distraction of political intrigue.
• Tax reform was going to be tricky at the best of times given the Republican goal of making the tax cuts permanent (avoiding the mistake of the Bush tax cuts). The constraints of the reconciliation process demand that a permanent tax cut be budget neutral over the long run. Tax cuts are not inherently neutral even once their dynamic effects are taken into account. This is why the border adjustment tax (BAT) remains in the mix – it has the theoretical capability of keeping the fiscal implications closer to flat.
• We still budget for a partial delivery of fiscal stimulus via tax cuts, but acknowledge that the size and prospect have both dimmed somewhat. Of course, it is still very early, and the delivery likelihood of some of the Trump administration’s less desirable platform planks such as protectionism have also fallen somewhat.

Peaking macro signals?

• After a sparkling run of strong economic signals, we are on alert for any evidence of peaking or deterioration.
• To be clear, there is no particular evidence as yet of a downturn. However, there is reason to believe that macro signals may struggle to strengthen much from here.
• Economic surprises are as positive as they’ve been in years, are no longer actively rising, and historically tend to mean-revert quickly.
• Purchasing manager indices (a classic leading indicator) are still quite strong and broad. A large 84% of countries are in growth mode, and an amazing 83% have strengthened further over the past three months. However, the pace of improvement may be slowing.
• Among these indicators, The U.S. edition – the ISM Manufacturing Index – has rarely exceeded its current reading and generally doesn’t spend too long in such rarefied air, either.
• It is thus our suspicion that macro signals cannot strengthen much further from here. By all means, they can likely remain fairly firm, and it is worth noting that the current ISM Manufacturing reading is consistent with a stunning real U.S. GDP growth rate of 4% per year (which we are highly skeptical will transpire, for what it is worth). But a shift in trajectory can sometimes weigh on markets, even if the underlying macro message is still fine.

Canadian budget review:

• The newspaper headlines described Canada’s 2017-18 budget as a status-quo outcome. In a literal sense, this was true: no major new programs or taxes were delivered, and none were eliminated.
• A closer parsing revealed a few areas of concentration, if on a small scale:

1. One such was a focus on families with young children (longer parental leave, more daycare funding, easier access to foreign nannies).
2. Another focus was innovation, though the sums of new money dedicated pale in comparison to the honking $23 billion already deployed annually in this direction to ambiguous effect.
3. Infrastructure remains a key theme, though the sum of money remains broadly in line with what was dedicated a year ago, and the expected infrastructure bank is still only loosely delineated.

• Of course, it is also useful to consider budgets via what they did not deliver. Counter to fears, this one did not raise taxes on the well-to-do; counter to hopes, nor did it do much to address the country’s housing issues.
• It should be noted that although there were no major new programs, federal government spending is still set to rise by a sizeable 5% over the next year. In other words, many of the commitments of prior years are still biting. As a result, Canada’s budget deficits are set to remain prominent for the foreseeable future, with a $28 billion shortfall in 2017-18.
• Optimists will argue that the forecasted deficits are small enough that Canada’s debt-to-GDP ratio will remain roughly flat over the coming years. Pessimists (and, arguably, realists) will note that a pattern of slippage is already evident with this government, and that recessions have a nasty habit of blindsiding the best laid budgetary plans. Canada’s AAA debt rating is not seriously threatened, but one could conceive of the outlook shifting from neutral to negative should fiscal targets be moved or missed again.

Canadian monthly GDP preview:

• Friday’s Canadian January GDP print seems capable of a strong performance. Our models point to an above consensus outcome (+0.5%), and the consensus of +0.3% is already a fairly strong expectation.
• It would seem that the country’s bounce is continuing, and with U.S. protectionism still off in the murky distance and Toronto’s housing market continuing its amphetamine-driven rise, the most acute threats to growth are not yet an issue.

Brexit Article 50 lies ahead:

• The British Conservative government is set to trigger Article 50 of the Lisbon Treaty on Wednesday March 29th, a long-awaited starting gun for the process of the U.K. extricating itself from the European Union.
• There is little that is certain after that.
• Technically, the Article provides for two years of subsequent negotiations, though there is nothing preventing these being wrapped up quite early (a position former Bank of England Governor Mervyn King has advocated) or for that matter receiving a special dispensation should the negotiations drag on for longer.
• One exciting rumour – though nothing more, at this point – is that the Conservatives could call a snap election to provide greater legitimacy to Prime Minister May and to capitalize on the weakness of the Labour party.
• April and May should be dominated by the release of position papers laying out the negotiating stances of the U.K. and EU, respectively. From there, negotiations should begin in earnest over the summer.
• Leaping forward to the conclusion, we still believe the ultimate Brexit deal will represent quite a sharp break between the two jurisdictions.

China PMI preview:

• A quick word on China in advance of the country’s PMI readings later this week. We can claim no special insight into these particular numbers, but are happy to stake claim to the below-consensus side of the market expectation as a general view.
• This relates mainly to the fact that Chinese policymakers have been tapping on the brakes over the past few months, raising interest rates, cutting government spending, hiking their vehicle tax and restricting home purchases.
• The renminbi is also no longer providing as active a tailwind, having ceased its deterioration over the past three months.

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