Donald Trump tax cut to lift growth

Rising momentum behind Donald Trump’s plan for tax cuts is fuelling expectations of faster growth in the US.

Donald Trump has put his plan for tax cuts back on the agenda.

Rising momentum behind US President Donald Trump’s long-awaited plan for tax cuts is fuelling expectations of stronger earnings for US companies and faster growth in the world’s biggest economy.

The Australian dollar continued to retreat after the announcement by Republican leaders — which includes a reduction in the US corporate tax rate to 20 per cent from around 35 per cent — as the greenback jumped on the back of a rise in US bond yields.

After hitting a two-year high of US81.25c this month amid rising expectations of a rate increase from the Reserve Bank and some lessening of US rate hike expectations, the Aussie slipped to a two-month low of US78c as its interest rate differentials versus equivalent US rates started to narrow.

On equities markets, the S&P 500 share index hit a record intraday high on Wall Street before closing up 0.4 per cent. Australia’s ASX 200 edged just 0.1 per cent higher.

Notwithstanding a lack of details and uncertainty over whether the President’s proposed tax cuts will be passed into law, economists said they should add to growth in the US.

“If passed in its current form and acknowledging that some key details are still missing, a good baseline is that this tax plan could increase GDP growth by at least 0.5 per cent per year,” said RBC Capital Markets chief economist Tom Porcelli.

“Critically, we think the fact that tax cuts are coming at the ­mature stage of the cycle, in a time of elevated confidence, rising incomes, healthy balance sheets rather than a typical post-recession environment, when households are still risk averse and in full balance sheet repair mode, means the propensity to spend could very well be higher than historically observed.”

Mr Porcelli said that in the next decade US GDP could be 5 per cent higher as a result.

Stronger US growth could have implications for the supply of Treasury securities and, more importantly, US monetary policy as the Fed hasn’t baked in any tax cuts to its forecasts.

“We think the economic reassessment that would follow the passage of such a plan, firmer GDP, lower unemployment, firmer inflation, would naturally, lead to an (upward) recalibration of the expected Fed funds rate, even without considering the composition of the Fed, which could become more hawkish next year given some of the names Trump is considering for governor.”

Mr Porcelli said the proposed reduction in the US marginal corporate tax rate to 20 per cent from about 35 per cent could also lead to a “non-trivial repricing in equities” if it comes to fruition.

He estimated a fall in the effective corporate tax rate to 20 per cent from 27 per cent would add $10.50 to the current aggregate earnings per share estimate of $1.50 for S&P 500 companies for one year. The forecast is conservative because the effective rate would be lower.

Assuming investors are still willing to pay 19 times earnings per share, the current 12-month forward PE ratio, this would add an additional 200 points (or 8 per cent) to the S&P 500.

“This is a direct flow-through to the bottom line and we’d also have to consider the impact from increased buybacks from not only a lower corporate rate but from repatriation flows.

“Moreover, we’d have to consider the positive knock-ons to top-line growth from a firmer GDP profile on the back of the individual tax reductions.”