The US Corporate Tax cuts that were passed into law at the end of 2017, begin a period of sustained structural growth in the US economy.
Since WW2, we have only two examples of periods of US growth following major tax reforms. The first was after the tax cuts of the 1960s introduced by the Kennedy/Johnson administration. The second was after the tax cuts of the 1980s introduced by the Reagan/Bush administration.
In both of these cases, corporate tax cuts generated sustained levels of higher corporate investment and higher economic growth. In both of these cases, this resulted in lower unemployment and higher living standards. In each case, this improvement in employment and living standards was sustained over the following decade.
The result of the Trump tax cuts should introduce a similar period of sustained growth in the US economy. Corporate investment will be stronger over a series of business cycles. Unemployment will be lower over a series of business cycles. Wages growth and improvement in the standard of living will be higher over a series of business cycles.
We have currently experienced a very deep recession in 2008 followed by one of the longest expansions in US history. What we can expect from now on is shallower and shorter business cycles.
Rises in unemployment when the US economy slows down will be less. This will generate a smaller stock of US unemployment to be absorbed in the next cycle of expansion. This means that business cycle expansions will be shorter. A lower level of average unemployment will lead to a higher average level of wages growth.
Thus, growth in living standards will be sustained over a series of business cycles. This is the kind of cyclical behaviour previously seen in the US economy in the 1960s and again in the US economy in the 1980s.
We think that growth in the US economy will accelerate from 2.3% in calendar 2017 to 2.7% in 2018. Growth should slow slightly to 2.5% in 2019. As a result of continued strong growth, unemployment should continue to fall until it reaches a low of around 3.8-3.9% by mid 2018. This very low level of unemployment will be equal to levels not seen since the beginning of this century. This low level of unemployment will generate a shortage of labour coming forward to fill the demand for employment. This labour shortage will then generate an increase in wages growth, which will rise quarter by quarter. This higher increase in wages growth will then put sustained upward pressure on core inflation.
The result of higher wages growth and higher core inflation, will be a more rapid rise in the Fed funds rate, than currently expected. We think that the Fed funds rate will be tightened four times in calendar 2018 and another four times in 2019.
The US Dollar
One of the mysteries that appears to currently beset the market is why, with such an outlook for a tightening Fed funds rate, do we see a falling US dollar? This lack of understanding of the weak US dollar is because of the lack of attention that has been paid to fiscal stimulus.
The cut in US corporate tax rates is achieved in part by an increase in the US budget deficit of around three quarters of 1%. This expansion of the US budget deficit adds stimulus to the economy that compensates for the rate hikes in 2018. If we take fiscal policy and monetary policy together there is little tightening of demand policy in the US economy in 2018. Demand conditions are much easier than is commonly understood. These easier demand conditions are leading to a higher US current account deficit and a lower US dollar.
Our current estimate is that, including the effect of US corporate tax cuts, US 12 month rolling operating earnings should rise by 22.3% in calendar 2018. These higher earnings will be reported quarter by quarter as we move through calendar 2018. This upward pressure on US corporate earnings should generate continuous upward pressure in the US equity market in the quarters ahead.
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