The New Budget — a Waste of Time; Trouble for China Trade Deal?
Author: Greg Valliere
March 11, 2019
THE BIGGEST WASTE OF TIME of the year in Washington is reading a new budget, and this year is no exception. If you want proof of this irrelevancy, look at the White House’s projected rate of GDP growth that will get us to an alleged balanced budget — 3.2% this year and 3% for the next decade, as if recessions have been outlawed.
HERE, IN A NUTSHELL, IS WHAT WILL HAPPEN: Both parties will exploit this morning’s new budget, with Democrats blasting deep domestic spending cuts and the Republicans calling for a huge defense spending hike, partly to fund a wall on the Mexican border. The debate will continue until a debt ceiling crisis forces some action this fall — when there will be a “kick the can” deal with a deadline just before Christmas, when exhausted lawmakers will agree to significantly more spending.
THE NET RESULT OF THIS PREDICTABLE PATH will be another dramatic increase of the federal deficit, which will prompt hand-wringing from the politicians — in public. In private, they don’t care, because the markets don’t care. And besides, no one wants to cut spending — which always is difficult but now is impossible because the liberal House would never go along and the Republicans have embraced a New Keynesianism that ignores red ink.
THE MOST IMPORTANT FACTOR FOR THE MARKETS AND THE ECONOMY is that surprisingly stimulative fiscal and monetary policies will persist, a life preserver for the economy. The Federal Reserve has made it clear that it won’t even consider a rate hike until summer or later, while a dramatic increase in spending is the likely outcome as both parties make trade-offs this fall.
ADHERENCE TO STRICT SPENDING “CAPS” has become an annual joke, as both parties debate how much to hike spending, not reduce it. The catalyst, as usual, will be defense outlays; President Trump wants another massive increase, from $716 billion this year to $750 billion in 2020 — with a huge hike in the slush fund known as Overseas Continuing Operations, which was justified when there were major wars raging, but the OCO account is now a piggy bank for the border wall.
DEMOCRATS WILL RESIST FUNDING FOR THE WALL, but in a final deal the president probably will get a few billion dollars, enough for some campaign boasting, while the Democrats will get still another exemption from the budget caps. The idea of a 5% across-the-board spending cut for domestic spending, to be proposed this morning, is absurd. Maybe funding for public broadcasting will get a haircut, a diversion from any serious debate on deficits.
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RATHER THAN FOCUS ON THIS NON-EVENT BUDGET, the financial markets may be on edge this week over two issues: First, is this winter’s economic air pocket about to end? Probably yes, although the closely watched Atlanta Fed GDP forecast calls for only 0.5% growth this quarter.
WE ANTICIPATE A DRAMATIC snap-back in the second quarter, thanks to continued solid real disposable income growth; higher wages are coming as the labor market tightens further. The outlook for the U.S. thus seems good, but the outlook for Europe is a genuine concern, as a messy Brexit looms at the end of the month.
SECOND AND PERHAPS MORE IMPORTANTLY for the markets, could U.S.-China trade talks bog down? We never bought the argument that a deal will be signed in a splashy ceremony at Mar-a-Lago by the end of this month; there simply are too many unresolved issues — enforcement in particular. But there’s been steady progress, especially on currencies, and a deal still seems likely this spring.
BUT WOULD CHINESE PRESIDENT XI travel to Florida to sign an agreement in principle in less than three weeks when many of the details are unresolved? As we wrote after the North Korean talks broke down, Trump’s walkout had implications for the trade talks; he likes to use uncertainty as a bargaining chip. Why would Xi take even a remote risk of a humiliation at the end of this month? The Chinese are increasingly clear — cut the deal in private, then sign it in public.
SO OUR ODDS ARE AS FOLLOWS: There’s a 70% chance of a real deal, with all the details, by May. Chances of a real deal by the end of March are slipping. The crucial issue, hard to handicap now, is whether there will be a pact with teeth. Trump and Xi will proclaim that the final product is historic, but trade hawks in both countries may beg to differ.
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