The driving catalyst behind the furious market rally since the presidential election has been the market's hope that Trump will unleash a "huge", still undetermined, debt-funded financial stimulus package, which will grease the volatile handover from monetary to fiscal policy, boosting inflation and rerating risk assets higher. Indeed, the market was so transfixed by this hope, that it has so far ignored all warning signs, duly noted previously on this website.
Nearly a month ago, we warned that when comparing Trump's proposed budget and the House's own budget blueprint, "An Unexpected $12 Trillion Hole Emerges In Donald Trump's Plan To "Make America Great Again"."
As we first demonstrated, there was a massive $12 trillion debt difference between the plan that Trump espoused, which envisioned a $5 trillion cumulative increase in debt...
... compared to the budget blueprint approved by the house earlier this year, which in turn seeks to reduce the deficit versus current projections by $7 trillion over the next ten years, mainly through spending cuts: the result is a $12 trillion "hole" between the Trump and the House budgets.
Needless to say, the market didn't care.
We followed up just a few days later with "A "Big Problem" Emerges For Trump's Economic Plan", where we reported that while the market may (still) be blissfully unaware about the emerging conflict between Trump's debt-fueled vision for the future, Republican politicians had started to notice. As we wrote, Republican lawmakers warned "that there could be a major obstacle to enacting President-elect Donald Trump’s agenda: the national debt."
“I was disappointed that it wasn’t brought up in the campaign — anybody’s campaign really — it really wasn’t mentioned,” Sen. Jeff Flake (R-Ariz.) said of deficits and debt. “So I’m very concerned about it. It’s going to be tough to address if there’s no push from outside of the Congress,” he added. “I’m very concerned about it. It’s the biggest problem we face, by far.”
“We did not hear anything about entitlement reform from either of the candidates, and that’s a serious issue,” said Michael Sargent, a research associate at The Heritage Foundation. “You cannot address the growth in spending without addressing entitlement issues.” Well, perhaps if the campaign was engaged in non-stop daily midslinging between Trump and Clinton, someone would have "heard" about it. Alas, now it is a little too late.
Compounding the problem is the expected Federal rate hike to arrest rising inflation, which would increase the cost of the nation’s debt. Flake noted on the Senate floor in September that for every quarter point that interest rates rise, the federal government would have to spend an additional $50 billion annually to service the debt.
Ultimately, the problem regarding the US debt is not so much Trump's, as that of Republicans who would have to support it. Readers will recall that Congressional Republicans assailed President Obama early in his tenure over soaring federal deficits, which exceeded $1 trillion dollars during his first four years in office. As a result, debt reduction was the main focus of GOP leaders after they took back control of the House in 2010. “It is a problem and going to be a problem. Don’t forget that Obama has doubled the debt and if interest rates were at their historic norms, the deficit would be $612 billion bigger,” said former Sen. Phil Gramm (R-Texas).
The market, once again, did not care.
That may change now, however, with Bloomberg reporting what we have been saying for the past month, namely that republicans, under Mitch McConnell, have "poured cold water on the idea of a massive stimulus package, effectively laying out markers on taxes and spending that that could cramp Trump’s ambitions."
As Bloomberg explains, Trump’s race to enact the biggest tax cuts since the 1980s went under a caution flag Monday when during a news conference, "Senate Majority Leader Mitch McConnell warned he considers current levels of U.S. debt “dangerous” and said he wants any tax overhaul to avoid adding to the deficit."
In other words, the market's narrative that Trump will be the president to pursue a seemingly "liberal" economic growth agenda, one funded by trillions in new debt issuance, just got a very rude wake up call.
“I think this level of national debt is dangerous and unacceptable,” McConnell said, adding he hopes Congress doesn’t lose sight of that when it acts next year. “My preference on tax reform is that it be revenue neutral,” he said. There is one problem with revenue neutral growth when it comes to risk asset prices: they, too, remain neutral.
In other words, if McConnell - who now appears set on collision course with the biggest drier of Trump's growth strategy - gets his way, the entire Trumpflation rally may be unwound.
Here, Bloomberg repeats what we have warned all along: "The Committee for a Responsible Federal Budget, a nonpartisan think tank, has projected that Trump’s plans would increase the debt by $5.3 trillion over a decade, with deficits already over $600 billion a year and rising on autopilot. If Trump achieves the plans he has laid out, “the deficit’s going to be a lot higher than expected, at least in the short term,” said Stan Collender, a budget expert and former Democratic congressional aide. It could rise to $1 trillion per year for four years, he said."
As for Trump’s infrastructure plan, touted as costing roughly $1 trillion but with more than 80 percent of the financing coming from the private sector, McConnell said he’s looking forward to seeing the details.
“What I hope we will clearly avoid, and I’m confident we will, is a trillion-dollar stimulus,” he said. “Take you back to 2009. We borrowed $1 trillion and nobody could find that it did much of anything. So we need to do this carefully and correctly and the issue of how to pay for it needs to be dealt with responsibly.”
Then there is the debt limit, which will need to rise next year to avoid defaulting on government obligations; McConnell said he wasn’t sure if that would be paired with any deficit-reduction measures next year as it was in 2011, when Republicans held the debt limit hostage and extracted more than $2 trillion in deficit cuts over a decade from President Barack Obama.
House Speaker Paul Ryan has also said he wants tax changes to be deficit-neutral, indicating that Republicans will assume positive macroeconomic benefits from tax cuts to ease the projected budgetary hit - a process known as dynamic scoring that is popular on the right.
McConnell offered little specificity on changes to Obamacare, saying the Senate would kick off the new year with an Obamacare resolution and then start working on a replacement. Simply waiting wasn’t an option, he said. “The notion that we could do nothing and allow the current law to implode is unacceptable,” McConnell said. “So, I hope no one believes no action is possible or appropriate.”
That replacement process could take as long as three years, according to Republican senators, although some conservatives, particularly in the House, want a much faster timeline. In the short term, eliminating all of Obamacare -- including its taxes and Medicare cuts -- would add to the deficit, the Congressional Budget Office concluded in 2015. Before the election, McConnell had said he hoped to work on limiting eligibility for programs like Medicare and Social Security if Hillary Clinton was elected. He didn’t repeat that call Monday. That in turn would make the optionality of any Trump debt-funded stimulus even more remote, and could forece Trump to choose between repealing Obamacare and pursuing tax cuts and economic stimulus.
Finally, even if all the changes are implemented immediately, and the GOP rolls over, virtually none of Trump's stimulus package will generate any impact on the economy until some time in 2018 as Goldman calculated last week.
One interesting wrinkle, as Bloomberg notes, is that Trump has named McConnell’s wife, former Labor Secretary Elaine Chao, to head the Department of Transportation, which would likely make her one of his point people on any infrastructure package. That particular "horse trade", may be the wildcard that helps Trump clinch his desired stimulus package, especially if no other Republicans dare to defy the President-elect.