July 2017 - Daily Markets & Politics (Greg Valliere - Horizon Investments)

July 31, 2017

What Comes Next? A Focus on China Sanctions

A DRAMATIC PIVOT: Health reform and other domestic issues will now take a back seat to geopolitics – where the greatest threat, in our opinion, is that U.S.-China relations could rapidly deteriorate as President Trump blames Beijing for not confronting North Korea. 

TRUMP NEEDS SCAPEGOATS, AND HE HAS PLENTY: First, on the Obamacare debacle, Trump has threatened to rescind government-paid health care for members of Congress. And he has threatened to allow health insurers to fail. Neither tactic will work; Congress doesn't respond to threats, but a modest bill that subsidizes ailing health exchanges is possible this fall.

A SHIFT AWAY FROM HEALTH CARE: We'll get a bit of a breather on health issues, with Congress gone for most of August. That's good for Republicans, who need to change the subject, and the White House needs to get comfortable with a new Chief of Staff, John Kelly, who we think is an excellent choice. If anyone can impose discipline, it's Kelly, the highly regarded retired four-star Marine general.

KELLY's FIRST CRISIS: Three huge geopolitical issues – 1) A deepening crisis with Russia, which will further divide the U.S. and Europe, where sanctions against Moscow are viewed as too harsh. 2) The likelihood of additional skirmishes in the Persian Gulf between the U.S. and the emboldened Iranians. 3) A sense that North Korea has gone too far and must be confronted.

TRUMP HAS NO GOOD OPTIONS on North Korea, and we take seriously the comments from UN Ambassador Nikki Haley, who said this weekend that further talks with Pyongyang are useless. A military option – strategic air strikes – is enormously risky but is clearly on the table; for now, the U.S. will ship more THAAD missiles to South Korea and stage more military exercises.

BUT TRUMP NEEDS A SCAPEGOAT for what looks like policy weakness, so he will continue to ratchet up his rhetoric against China. This may may lead to fresh economic and trade sanctions against the Chinese, perhaps announced later this week. This may be playing with fire. Unlike, say, the Canadians – who cannot retaliate massively – the Chinese can, and the prospect of deepening trade tensions with Beijing could be worrisome for the markets.

BOTTOM LINE: We still believe there are only two things that could derail this booming stock market – death of tax cuts or a genuine geopolitical crisis. The tax cuts are still alive, and will plod along this fall. The wild card is geopolitics in general and relations with China in particular.

July 28, 2017

Worst Week of Trump's Presidency – and It's Not Over Yet

THE TRUMP ADMINISTRATION is in disarray, the president's agenda is in tatters, and there's only one significant plus he can point to – an economy that is growing decently. Otherwise, there's no reason to believe the downward spiral will end any time soon.

LAST NIGHT'S STUNNING DEFEAT of an Obamacare replacement probably ends this futile effort; regular readers know we feared the entire summer would be wasted in this quixotic pursuit, and it was. Perhaps there will be a bill by October to prop up failing insurers, and perhaps there will be a provision killing the device tax, but health reform is a hot stove that GOP leaders will not want to touch again any time soon.

WHAT ABOUT THE BUDGET AND TAXES? It will take weeks to iron out a debt ceiling increase and a budget resolution this fall; once again, deep divisions among Republicans complicate the process. Tax reform will begin moving later this fall, and a vague declaration of principles yesterday by the key GOP players did include an important declaration that the Border Adjustment Tax is dead. So maybe tax cuts can pass by winter, but yesterday's health debacle doesn't bode well. 

THE COMING DEPARTURES: Friday afternoons in Washington traditionally are reserved for dumping bad news, and today may be no exception. It's inconceivable that Reince Priebus will stay at the White House, not after the vulgar goon Anthony Scaramucci declared war on him. Other departures could be coming; officials at the Pentagon are livid over being blindsided over transgender troops, and there's only so much humiliation Jeff Sessions can endure. 

THE BIGGEST PROBLEM – TRUMP HIMSELF: It's an understatement that Trump's temperament – most clearly on display in an appalling speech to the Boy Scouts – has made him a pariah in Washington; we'd guess that well over half of all Republicans would be thrilled to see him gone, replaced by the boring but solid Mike Pence. 

THAT'S NOT GOING TO HAPPEN ANY TIME SOON, which means we're stuck with this furious president, who is obsessed that the Russia probe is now delving into his finances. He wants to fire Robert Mueller, which would provoke a firestorm in both parties and would make us worry – what new distraction, like transgender troops, would Trump embrace? Would he seek to divert attention with a geopolitical crisis?

PERHAPS THE DYSFUNCTION WILL COOL OFF during the dog days of August, and perhaps there can be a focus on the still-improving economy. But we have to worry, after this ugly week, that Trump, Jared Kushner, Scaramucci – all arrogant New Yorkers – are in way over their heads, unwilling to take guidance from those who know how Washington works.

July 27, 2017

White House Considers Plan B For Tax Bill

AN IMPORTANT SHIFT? Officials at the White House, exasperated by the snail's pace for legislation in this Congress, are reportedly weighing Plan B for the tax bill– a stripped down tax cut, with very little reform.

THE "SKINNY" PRECEDENT: The goal, as we have frequently written, is to get something– anything– to a House-Senate conference committee, which is the Plan B for an Obamacare replacement, still hanging by a thread and potentially facing more torturous deliberations this fall. Suddenly, a similar Plan B has emerged as a tax option, and we think it would be easier to enact than the health bill.

REFORM IS REALLY DIFFICULT: From what we've heard, there still isn't agreement among Republicans on a Border Adjustment tax (probably dead), the deductibility of business debt, the elimination of individual tax breaks, etc. This has raised a nightmare scenario of tax reform debate dragging well into 2018. So why not just cut taxes?

WE HAVE ARGUED THAT TAX REFORM should be the goal; Paul Ryan and other congressional Republicans consider this the best opportunity to enact a once-in-a-generation reform package, but the dysfunction that grips Washington on so many fronts makes many Republicans leery of anything grandiose on taxes.

THUS THE APPEAL FOR PLAN B: As the Washington Post and others have reported in recent days, tax cut advocates Larry Kudlow and Steve Moore have urged the White House to consider a stripped-down bill that would have three major components:

1. A cut in the top corporate rate from 35% to about 15%, although we don't think Congress can afford to go that low. A sharp tax cut for the wealthy doesn't seem affordable, either; a decent middle-class tax cut has more appeal at the White House.

2. A doubling of the standard individual deduction, which would make tax exemptions far less appealing.

3. Repatriation of tax revenues stashed abroad by U.S. multinationals, combined with fixing the "territorial" tax system.

ALL THE OTHER CONTROVERSIAL TAX REFORM IDEAS would be deferred until 2018 or beyond, if the White House adopts this Plan B, which theoretically could pass by winter. But major questions persist, including whether the bill should be revenue-neutral. Key tax players, including Ryan and Treasury Secretary Steve Mnuchin, are close to unveiling a set of principles, perhaps in the next few days.

HOW WOULD THE MARKETS REACT? The markets are counting on tax cuts; a sharp drop in the top corporate rate would be a major plus for small-cap companies, many of which pay close to the 35% top rate. Even a stripped-down bill would be a positive, especially if the markets begin to see signs of progress by late October. Republicans and President Trump desperately need a victory, and Plan B would be sufficient. 

FOR NOW, ALL THE MARKETS NEED TO SEE is progress, amid the staggering chaos over Jeff Sessions, transgender troops, the Russia probe, the health reform mess, etc. And there has been progress, beneath the radar, as key GOP negotiators inch toward a tax compromise plan. If health reform is the template, skinny would be better than nothing on taxes.

July 26, 2017

Senate Considers a "Skinny" Health Bill – 5 Quick Conclusions

WILY MITCH McCONNELL MAY HAVE A FEW MORE TRICKS up his sleeve, but it appears that his best hope – called "skinny repeal" – would require a House-Senate conference that won't be resolved until after the August break. Already hopelessly behind schedule on budget issues, this could paralyze Congress as the end of the fiscal year looms on Sept. 30.

AS WE SUSPECTED, McCONNELL GOT just enough votes to bring Obamacare replacement to the Senate floor, but that was the easy part in this mind-numbing process. Five quick conclusions:

1. A repeal bill with no other features has absolutely no chance of passage.

2. There's also no chance for a bill to kill Obamacare with an effective date two years from now, and it appears that there could be as many as nine potential GOP defectors on bills that repeal and replace Obamacare with anything close to the pending Republican proposals.

3. The latest fallback, the only one that has much of a chance, is a "skinny" repeal, which would end the Obamacare mandate, and scrap the requirement that employers with over 50 workers provide health insurance, while killing the medical device tax.

4. Dozens – perhaps even hundreds – of amendments will be offered on the Senate floor in the next two or three days. Democrats will have an opportunity to pile on the amendments, which will take many hours.

5. It's not easy to figure McConnell's goal, but it may be this: get something – anything – to the House with a goal of patching together even a shell bill which could get to a conference committee.  The problem, of course, is that this option would drag the health reform mess well into the fall.

TIME IS RUNNING OUT: The House will leave town on Friday for a five-week break, and the Senate will soon follow, which will leave the heavy lifting on budget issues until post-Labor Day. There are two huge tasks – Congress has to pass a budget resolution, which will contain crucial instructions on tax reform, and it has to raise the debt ceiling. Both issues are stalled. (The actual appropriations bills probably will get lumped into a massive continuing resolution that will extend through December.)

ALL OF THIS IS COMPOUNDED by a president who has stepped on his message once again. Instead of rejoicing that McConnell got the Obamacare bill to the floor of the Senate, Trump has ratcheted up his effort to humiliate Jeff Sessions into resigning. Several other top Trump officials, sensing they could be under the bus soon, may leave in August.

THE GOOD NEWS: We still don't think Washington can really annoy the markets until fall at the earliest, when it will become clear that budget issues are just as difficult as Obamacare repeal. But the good news will be on display today – the Federal Reserve will make clear that it's comfortable with tapering its balance sheet this fall because the economy can tolerate it. 

YET THE FED can afford to go slow on rate hikes, perhaps waiting until December, because inflation is still tepid. We give the Fed an A-plus this year, in marked contrast to Congress and the White House, which got a well-deserved smackdown from John McCain yesterday, perhaps because he knows the climate may deteriorate even further this fall.

July 25, 2017

The Top Dozen Questions We're Getting From Clients

WE ENCOURAGE YOU TO EMAIL OR CALL, we enjoy getting your input. We get lots and lots of questions, so here goes with the Top Dozen questions we've gotten lately:

1. Will Donald Trump Serve Out His First Term? You'd be surprised how often we get this question. Our answer: probably yes. Nearly half the country wants him impeached, but the House and Senate won't go along unless he fires Robert Mueller. That would be a game changer, a genuine Constitutional crisis, but we don't anticipate it.

2. Who's Next to Go? There's no end to the dysfunction and in-fighting. Here are the officials most likely to be gone before winter: Jeff Sessions, could be out by next week; Reince Priebus, hanging on by a thread; Rex Tillerson, telling friends he may not last until year-end; and national security adviser H.R. McMaster, increasingly frustrated with the White House. Steve Bannon seems safe for now.

3. Can a Health Bill Still Pass? High drama today, with John McCain back in the Senate, an emotional jolt that could give Mitch McConnell a fleeting victory – perhaps the Senate will agree to consider a bill, but a procedural victory is unlikely to lead to the passage of an Obamacare repeal or replacement. One wild card: could the Senate agree to continue debating this into the fall?

4. What's the Effective Date of a Tax Bill? We get this question almost daily, and the answer is no one knows for sure. Our best guess – an effective date of next April 1, but we wouldn't rule out July 1. An effective date any time in calendar 2017 seems unlikely.

5. Could there be a Government Shutdown This Fall?  Here we go again – get ready for media hype about an Oct. 1 shutdown or a federal debt default. Chances of a shutdown are 25%, chances of a debt default are 5%. Budget issues – not tax reform – will be the big domestic story this fall.

6. Whatever happened to infrastructure? Little enthusiasm, no money and still no proposal from the White House. Not only is an infrastructure dead for this year, it faces an uphill fight in 2018 as well.

7. Why Has the Deficit Faded as an Issue? Enormous battles loom this fall on the extent of defense and domestic spending, but only a loud minority of lawmakers really seem to care about the deficit. Why? The markets are fat and happy; the bond market vigilantes are nowhere to be seen. Without angry markets, this issue will stay on the back burner.

8. Could Janet Yellen Stay as Fed Chair?  If Trump wants low rates, she's his best bet, but our sense is that the president wants his own person on issues like bank regulation. Our friend Jeff Cox at CNBC reported months ago that Trump's powerful economic adviser, Gary Cohn, is the favorite to replace Yellen next February, and that still seems likely.

9. Will there be a "Wave" Election Next Year? Wishful Beltway thinking, in our opinion. The Democrats could add 15-to-20 House seats, but they need 24. Republicans still look likely to add two or three seats in the Senate to their present total of 52, although a loss looms for the GOP in Nevada. There are simply too many vulnerable Democrats – at least half a dozen – for the party to take the Senate.

10. Are the Democrats Getting Their Act Together? The party's new manifesto, poll-tested to aim for the middle class, is surprisingly populist; the pharmaceutical industry is a major target. The problem isn't necessarily the party's message – it's a lack of dynamic messengers. With a bench so thin, the path is wide open for Elizabeth Warren, who would terrify the markets.

11. What worries us on geopolitics? Nothing much, really. Status quo everywhere. Trade war never materialized.

12. Why Won't Trump Stop Tweeting? This is the Number One question we get, even from Trump supporters. Tweets are his way of bypassing the media and getting directly to his base, and it keeps him in the news cycle. But at least a third of his tweets are self-inflicted wounds that divert attention away from his agenda. He's 71, and NO ONE can tell him to cut back on the French fries, or get some exercise – or stop the tweets.

July 24, 2017

The Fabulous Fundamentals; Showdown on Health Bill – Finally

WHAT TO MAKE OF LAST WEEK? It really did seem like the wheels were coming off the wagon – Jeff Sessions now being undermined by the White House; still no progress on health reform; Sean Spicer driven out; President Trump talking about pardons and hinting that Robert Mueller could be fired. Great fodder for the Sunday talk shows – but for the financial markets the only thing that matters are the fundamentals.

WE HAVEN'T BUDGED FROM OUR CENTRAL 2017 PREMISE: Goldilocks fundamentals will persist – moderate economic growth; a dramatically healing labor market; inflation still below the Federal Reserve's target; steady interest rates; and very solid corporate earnings. There isn't a recession in sight – not with full employment and the stimulus from real disposable income growth. Yes, Washington is an irritant, but it's not a stock market-killer. 

IN FACT, WE WOULD MAKE A CONTRARIAN ASSERTION: Not only is Washington NOT a market negative, but it's actually been a positive, despite all the drama. Why? In a word, policies – a very pro-business, anti-regulation climate, a Federal Reserve determined to stay dovish, a focus on fiscal policy reform. What was the big market concern in January? A trade war, but that threat has dissipated.

THE DYSFUNCTION IN THE WHITE HOUSE grabs all the headlines, largely because Trump's tweet-storm is a huge distraction, and because the media loathes Trump. The White House obviously is struggling, but the markets won't get truly worried about Washington unless tax reform looks dead. It is not dead, but a tortuous process lies ahead before a bill begins to move late this year. Part of that tortuous process continues this week as the Senate takes one last shot at Obamacare reform.

MITCH McCONNELL'S REPUTATION as a master tactician has taken a serious blow, and it may not recover this week. He may schedule a vote tomorrow or Wednesday to begin floor debate, but that may fail. Even if this procedural vote wins, there will be no passage – barring a miracle – of a repeal bill, or a repeal and replace bill. Trump will scold and threaten his own party, and this will raise more anxiety about tax reform.

A ROCKY ROAD: If the markets finally sell off because of Washington, it probably won't come until the fall (the dollar, of course, has gotten a head start). The stock market has given up on health care, but a brawl over budget issues this fall – with the threat of a shutdown or default – would heighten concern, especially over taxes. 

BUT WE CONTINUE TO BELIEVE that the path will be relatively clear by mid-October to begin some serious work on taxes – the one area where the Republicans absolutely, positively have to succeed. The markets are counting on it.

July 18, 2017

The Tattered Trump Agenda – What Comes Next on Health Reform, Trade, Budget, Taxes

IT'S AN UNDERSTATEMENT that Donald Trump badly miscalculated on his legislative agenda; moving first on Obamacare repeal and replacement was a disastrous – and hubristic – decision that has begun to worry the markets, as the dollar's slump persists. So let's take a look at the tattered agenda.

HEALTH REFORM TRIAGE: Mitch McConnell probably will not succeed with his Plan B – a repeal of Obamacare, taking effect in two years. Theoretically a replacement bill could pass during that period, but if the Republicans couldn't agree on a replacement for the past seven years, what makes anyone think they can do it in the next two? So McConnell has to consider the unthinkable – seeking support from Democrats to prop up shaky insurance exchange markets.

THE GOP BASE ALREADY HATES McConnell and Paul Ryan, who are viewed as Republicans in Name Only, and the idea of working with Chuck Schumer and Nancy Pelosi will further divide this fractious party. Nevertheless, there's a decent chance of a deal to boost federal cost-sharing subsidies while offering regulatory relief to public insurers. There are lots of moving parts that come with this option, including whether all states will go along with a bipartisan deal.

LAST NIGHT'S DEATH OF THE HEALTH BILL is an unmitigated disaster for Trump, who said last year that it would be easy to replace Obamacare with “something terrific.” Now the markets have to wrestle with the likelihood that his famed negotiating skills don't work in the shark-filled waters inside the Beltway. And it won't get any easier...

THE NEXT HUGE ISSUE will be the budget, but first a word on the Trump Administration's NAFTA reform outline yesterday. Trade protectionists on the left and right were howling that the plan is vague and toothless, but the reality is that U.S. businesses, farmers and most trade associations have been working furiously behind the scenes to preserve the trade pact without major changes, and they probably will succeed.

NO TRADE WAR: We could see some changes in rules of origin provisions, and there will be ongoing disputes such as Canada's refusal to accept U.S. poultry and dairy products, but it strikes us that the Goldman Sachs faction in this administration has prevailed – no trade wars, maybe some tinkering of NAFTA, with no resolution until early next year. Lots of smoke but no fire on protectionism – a good story, in our opinion.

THE LOOMING BUDGET CRISIS: Two huge issues this fall – 1.) Raising the debt ceiling, still another issue that has divided Republicans, with Treasury Secretary Steven Mnuchin favoring a clean bill and conservative deficit hawks insisting on attaching budget cuts. And 2.) Enacting a budget resolution that could easily bog down in the Senate after the House passes a bill with steep spending cuts. These two fights could drag on past the Oct. 1 start of the fiscal year; a government shutdown is not out of the question.

TAX REFORM: Call us stubborn but we continue to believe that despite a train wreck on health reform, broken promises on trade and a huge battle on the budget, tax reform is still likely. It will come later than Trump and the markets prefer, and a revenue-neutral bill will limit the extent of tax cuts. But as we wrote last week, the real story is tax reform, especially for business – and that has overwhelming Republican support.

BOTTOM LINE: The markets' concern about a dysfunctional administration – rarely on message, distracted by the Russia probe – may actually intensify in coming weeks, with more uncertainty on legislative policies. But by Thanksgiving the domestic focus will be almost exclusively on taxes, with a bill finally moving in Congress. If tax reform can be enacted by spring – which we still think is the most likely scenario – the mess this summer and fall will be largely forgotten by the markets.

July 17, 2017

GOP Health Reform Plan Suffers Critical Setback

SOMETIMES AN EVENT COMES FROM LEFT FIELD, totally unexpected, that changes the narrative of a major Washington issue. That surely applies to the GOP Obamacare reform bill, now stalled for weeks because John McCain may be far sicker than his aides portrayed this weekend.

A CRANIOTOMY IS A SERIOUS PROCEDURE, usually requiring several weeks of recuperation. Perhaps more alarming is what prompted the surgery to remove a blood clot above his left eye – McCain, 80, has suffered from melanoma near the eye, which could have bled into the brain, doctors told the New York Times. And recently McCain seemed disoriented at a congressional hearing.

EVEN IF McCAIN WAS PERFECTLY HEALTHY, the Obamacare rollback bill was in serious jeopardy; we gave it only a 35% chance of passage last week, before McCain's surgery. Trump Administration officials made no progress this weekend with Republican governors who hate the bill, and public opinion polls overwhelmingly reject the GOP plan.

AND THEN THERE'S THE ENORMOUS COMPLICATION of still another Congressional Budget Office "score," coming later this week, perhaps as early as tomorrow. It undoubtedly will show that this latest version’s Medicaid cuts will deprive millions of Americans of health care – perhaps the final blow, giving moderate GOP Senators their excuse to abandon it.

WHAT HAPPENS NEXT? A long delay in the Senate surely won't help the bill's prospects, so it's likely that Congress will leave for its August break without resolving the health issue. The post-Labor Day agenda is enormously crowded, with a budget brawl looming as House conservatives seek massive spending cuts that undoubtedly will be rejected by the more moderate Senate.

WHERE DOES THIS LEAVE TAX REFORM? The Trump White House, suffering from terrible polls and an inability to stay on message, desperately wants to get the tax debate moving this fall, and we think the House will begin to move. But chances of actually enacting tax reform this year, already slim, have suffered still another blow because of the health care delay.

Political calculations about the health bill overlook the impact of an American giant, a man of uncommon courage who was tortured for five years in a North Vietnamese prison. John McCain is a fierce patriot, scathingly outspoken and often self-deprecating at the same time. When he eventually leaves the Senate, that body will be greatly diminished.

July 13, 2017

Long-Overdue Tax Reform is Still Likely in 2018

INVESTORS WE TALK WITH are sick of the Russia story and the endless debate over an Obamacare replacement bill. What they really want to talk about is tax reform – the most important macro policy issue, by far, for the markets.

AMID THE PERVASIVE GLOOM AND DOOM in Washington, there's growing speculation that tax reform may be dead, but we disagree. Tax reform most definitely is not dead; there's been progress behind-the-scenes, and we still think a bill – with very positive implications for business – will begin to move this fall. That's the good news.

THE BAD NEWS is that the final bill will be far more modest than proponents hoped earlier this year. That's because deficit hawks are determined to make the bill "revenue neutral," and two key sources of revenue – a Border Adjustment Tax and extra money from an Obamacare replacement bill – look tenuous at best.

BUT A TAX BILL STILL CAN PASS because a likely budget resolution this fall will include an instruction to pass revenue-neutral tax reform, thus putting the process on a path that will require only 51 votes for passage. This so-called "reconciliation" process is the key to getting a bill enacted, and the Republicans have the votes.

OUR SOURCES ON CAPITOL HILL report that Republicans are desperate to change the subject from Russia and Obamacare, and are willing to compromise on taxes. Key example: Paul Ryan and Kevin Brady, the two leading GOP tax writers, will reluctantly abandon or water down their border adjustment tax plan if that means a bill can advance.

PRESIDENT TRUMP WANTED A MUCH BIGGER BILL than the one that will emerge this fall, but at this point he will gladly take anything (same scenario for a health bill – just give the man something to sign and he will do it, happily). So he will have to settle for less; the top corporate tax rate will not fall to 15%, as Trump wanted; it probably will wind up in the low-20s.

LIKEWISE, A REVENUE-NEUTRAL BILL might not accommodate three individual tax brackets as low as 35-25-10, as Trump wanted, and it increasingly appears that wealthier Americans will not get much of a net tax reduction because itemized deductions will be slashed. Our sense is that the individual cut will be modest – Ryan will lead a fight for fundamental tax reform, not big tax cuts.

BUSINESS TAX REFORM WILL BE THE KEY: Officials working on the bill agree that the key to stronger economic growth is a revitalization of the sluggish business sector. That's where tax reform is absolutely crucial for the markets, and we think the final bill will have several pro-growth provisions: the repatriation of earnings from abroad, a new territorial tax system, accelerated depreciation, and much more generous treatment for pass-through firms. And even if the top rate falls to only 24%, that's a big drop from the present 35% rate.

THE CRITICS WILL HOWL if there's any cut for the wealthy; there will be a firestorm over killing the state and local tax break; cynics will say that the bill relies on "rosy scenarios" for revenue assumptions. But this strikes us as an easier bill to pass than Obamacare reform.

BOTTOM LINE: Don't give up on tax reform, it's plodding along and still has a better than 50% chance of passage by next spring – just in time to give the economy a little boost ahead of the 2018 elections. The bill may lift GDP only modestly, but the reforms – accelerated depreciation, curbs on itemized deductions, etc. – are long overdue. And we'd gladly take real reform rather than a temporary sugar high from a huge individual rate cut.

July 12, 2017

Janet Yellen May Go; Fatal Flaw in Health Bill; What About Kushner?

LET'S NOT BEGIN WITH DONALD TRUMP JR. THIS MORNING: Let's begin with a Washington story that will grab the markets' attention – Janet Yellen's mid-year testimony to Congress, starting in the House this morning. There will be one intriguing story line – not interest rates, which will rise at least once more this year, or reducing the balance sheet, which will begin in the fourth quarter.

THE REAL FIREWORKS will be over curbing the Fed's authority; Yellen has many antagonists in the House, led by Rep. Jeb Hensarling, who will grill her today on Fed over-reach. She preemptively explained late last week why the Fed should remain independent, but there's no guarantee that she will prevail – especially since the White House is strongly leaning toward replacing her, as Politico reports this morning, with Gary Cohn.

THE OTHER NON-TRUMP STORY is Mitch McConnell's decision to reduce the Senate's August break by two weeks in a last-ditch effort to save the Obamacare replacement bill. It's tempting to conclude that McConnell still has a chance of saving the bill (maybe 35%), but this move strikes us as a fake-out.

THE SENATE DEAL-BREAKER: We simply can't see the House accepting a Senate bill that apparently will retain the 3.8% Obamacare tax on wealthy individuals, or the 0.8% payroll tax hike. This will infuriate conservatives. Nevertheless, McConnell will show the White House and the party that he's willing to give this one last try, even though he's at least ten votes short. He will use some of the two extra weeks to approve nominations and lay the groundwork for the next big issue, writing a budget.

AS FOR THE TRUMP STORY, is there any angle that hasn't been fully covered? Yes – the presence of Jared Kushner and Paul Manafort in the Russian meeting, and their inclusion on the email trail; you can be sure Robert Mueller took note of that. Kushner seems to float above these scandals, but his luck is about to run out. Manafort is even more intriguing – he eventually will have to testify and already there's speculation about what he may divulge in an effort to avoid incarceration.

JUST WONDERING: There's a very small list of who may have knifed Trump Jr. – who sent the explosive emails to the New York Times? Was it the Russians? They may have sent a signal to the president that they can damage him whenever they want, but could there be a leaker in the White House who wants Kushner out? The plot thickens.

July 10, 2017

The Scandal That Won't End

LIKE MOST OF YOU, we would prefer to focus on policy – tax reform, infrastructure, health care – but there's never any relief from the ongoing scandal over Russia's involvement in last year's election. President Trump has inflamed the issue by initially accepting Vladimir Putin's absurd denials of involvement – now Trump has hastily abandoned a plan to launch a joint cyber terrorism effort with Putin after the idea generated scathing derision from leading Republicans.

AND NOW COMES ANOTHER BOMBSHELL: Donald Trump Jr. and others in the Trump inner circle granted a meeting last summer to a Russian lawyer known for her Kremlin ties. She alleged improper activities by Hillary Clinton, and that was enough to get her the meeting. This story will join a huge backlog of cases that will be probed by Special Counsel Robert Mueller, who is relentless and not as indiscreet as James Comey.

WE STILL DON'T ANTICIPATE IMPEACHMENT – there aren't enough votes in the House to indict or in the Senate to convict. But since Trump is incapable of moving on – he's obsessed with the Russia story – he, ironically, will keep it alive. And that has major implications for his agenda.

A STRONG PRESIDENT, with a job approval rating above 50%, would knock heads and demand passage of an Obamacare replacement bill, but Trump continues to hemorrhage support, both among voters and on Capitol Hill. Health reform is on life support; we're not quite ready to throw in the towel because Mitch McConnell is a formidable player, but we think he's ready to move on to budget and tax issues.

IT LOOKED LIKE A SOLID TRIP TO EUROPE, after Trump delivered a well-received speech in Warsaw. As for Trump's estrangement with the rest of the world on trade and climate issues – well, he promised this in the campaign, so it wasn't a surprise. But anti-Russian hawks, especially on the GOP right wing, were incredulous over what they perceived as Trump's naivete with Putin.

EXASPERATED WITH TRUMP, Republicans will respond to this latest flap with Putin by passing stiff new trade sanctions against Russia – still another issue that will obstruct Trump's agenda. A recurring theme: Trump has to worry more about the Republican establishment than Democrats. People ask us daily – does the public really care about the Russia story? Maybe not so much, but Congressional Republicans do.

IS THERE A SILVER LINING? Leading Republicans on Capitol Hill know they have to distance themselves from Trump and work without him on a budget and a debt ceiling hike; by October there will be glimmers of life for tax reform, which could pass by late winter. These Republicans know how to use reconciliation and other tools that can bring them legislative successes; they have the votes to move a tax bill, but they agree in private that the White House is a liability, not an asset.

SO THERE'S STILL A CHANCE CONGRESS FINALLY WILL MOVE, but there's decreasing hope that Trump will magically morph into a credible president. Lyndon Johnson obsessed and miscalculated on Vietnam, and lost most of his political capitaL; Trump obsesses and miscalculates over Russia, and his self-inflicted wounds have become debilitating.

July 7, 2017

Republicans Consider the Unthinkable on Obamacare Replacement

BATTERED BY HOSTILE VOTERS back home and unable to win a consensus among Republicans, Senate Majority Leader Mitch McConnell and his allies are considering the unthinkable: passing a modest "Obamacare lite" bill to bolster health exchanges, or -- incredibly -- asking Chuck Schumer for help. And most astonishingly of all, lawmakers are talking about scaling back the five-week August break.
THIS STORY LACKS THE DRAMA of the G-20 summit, which inexplicably is being held in one of the most radical, left-wing cities in the Western world, with predictable optics. This contrasts with the sleepy mood in Washington, which will perk up next week as Congress returns to the health care impasse.
ENOUGH IS ENOUGH?  Republicans we talk with are impatient -- they want to ditch the health debacle and move on to pivotal budget issues and then, of course, begin deliberating tax cuts. So they're considering a fallback health bill that would fund the health exchanges. "No action is not an alternative," McConnell said yesterday.  But what the Senate is considering would seem to have little GOP support in the House.
READING SCHUMER'S MIND: The Senate Minority Leader immediately, and disingenuously, praised McConnell's desire for a compromise as "opening the door to bipartisan solutions."  What Schumer wants unquestionably would alienate GOP conservatives, but by injecting himself into negotiations (even if doomed to fail) Schumer could claim that he and the Democrats tried. 
SO HERE WE ARE, with Congress back early next week, with no resolution in sight for at least another week or two -- the new goal has shifted again; it's simply to finish a health bill before the August break.
CONGRESS NEEDS A KICK IN THE PANTS, and a scaled-back August recess would be a good start. But we simply don't see that happening, unless Trump calls lawmakers back into session. What does this mean for markets? Congress will return after Labor Day with no health bill enacted into law, huge budget issues -- and no tax reform in sight.
HOW IRONIC -- TRUMP IS OFF TO A DECENT START in Europe, with a speech in Poland that generated mostly solid reviews.  If Trump can refrain from tweets and controversies, he may return to Washington next week in better political shape -- but major progress on health reform isn't imminent.  Even the legendary tactician, Mitch McConnell, eventually may have to settle for a quick fix with Democrats.

July 6, 2017

The Complicated Political Landscape – Three Parties, Not Two

DONALD TRUMP, headed into high-stakes meetings in Europe, leaves behind a confusing political landscape in Washington, with essentially two Republican parties divided over key policies this fall. And it's unclear which faction Trump belongs to.

FIRST, THE DEMOCRATS: It's dawned on them that a coherent message might be a good idea, so they're test marketing in the field. Their new slogan apparently will be "A Better Deal," an obvious throwback to FDR, expect 90% of voters have no idea what the New Deal was. The Democrats are united on new spending, more social programs, and higher taxes – maybe not a winning combination, but at least the party is fairly united, more so than the GOP.

THE CHAMBER OF COMMERCE REPUBLICANS: Led by Paul Ryan and Mitch McConnell, these Republicans have been surprisingly inept this year, unable to move health reform or tax cuts, losing battles on free trade. Insurgent Republicans and talk radio have stirred up the GOP base, which – to be blunt – despises Ryan and McConnell as Republicans in Name Only.

THE STEVE BANNON INSURGENTS: Trump's populist adviser is still a major force. Bannon reportedly wants a tax increase on the wealthy; "I want a top tax rate with the number 4 in front of it," he said recently. And some GOP populists, desperate to replace Obamacare, have floated the idea of keeping the 3.8% tax on net investment income for individuals making more than $200,000 per year and married couples making more than $250,000. This has horrified the Wall Street Journal editorial page.

WHERE WILL TRUMP COME DOWN? He's distracted now by far bigger issues – his isolation from Russia, China, Western Europe; the deepening Korean crisis; and the steady progress by Special Counsel Robert Mueller. So Trump will take anything he can get on health reform (there's still a chance, but below 50%, that the Senate can pass a bill) and tax reform (where Republicans have given up waiting for a White House proposal, which has now been delayed until fall).

THE PROBLEM FOR THE GOP ESTABLISHMENT is Bannon's instinctive dislike for the status quo – and Trump's growing estrangement from Ryan and McConnell, who have been harshly critical of Trump's tweeting. This is a president who knows he got elected in Youngstown, Ohio and Bethlehem, Pa., so naturally he called the House Obamacare bill "mean." Trump listens to Bannon, and as a result there will be continued divisions over trade, taxes and health between the White House and the Chamber of Commerce Republicans.

THE GREAT WILD CARD: Trump is suspicious of trade deals, he wants everyone to have health care, he may not favor huge tax cuts for the rich – which, essentially, is the Democrats' position. Could Trump align with the left? There's some logic to that scenario, except logic doesn't apply very often in Washington. The country wants bipartisanship, but Chuck Schumer and Nancy Pelosi won’t negotiate with the GOP – they want to keep their party from splintering, as the Republicans clearly have.

July 5, 2017

Geopolitics – the New Factor in the Equation

COMING BACK FROM EUROPE, where our biggest concern was obnoxious smokers at outdoor restaurants, is more jarring than usual this year – because virtually every major story is more jarring than usual...

NORTH KOREA: A red line has been crossed, and there's no easy answers for ICBMs that can hit Alaska. Joint U.S.-South Korean exercises won't make much of a difference. China won't help much; either will more sanctions. Chances of U.S. air strikes on North Korea's missile sites, once unthinkable, are up to 30%. Our suggestion: a massive U.S. cyberwarfare campaign against North Korea and its missile program.

TRUMP IN EUROPE: Get the tear gas ready. We've spent two weeks in Europe, where the view of Donald Trump is, to put it mildly, incredulous. Protests will be a big part of the story in the coming week, but the media will focus on Trump’s meeting with Vladimir Putin – which may produce a pleasant surprise, as both pledge unity against Islamic terrorism.

TRUMP IN AMERICA: The juvenile wrestling tweet was a last straw for many Republicans; how can Trump work with a GOP Congress that has nothing but contempt for him? His agenda is on life support; health reform is such an albatross that Republicans increasingly favor abandoning all reform efforts; tax reform is months away. The obvious fix would be bipartisanship, especially on health care, but that dog won't hunt.

THE CONGRESSIONAL WILD CARD: There's been shockingly little progress on the budget; defense will get a big raise, but there's little agreement over details on domestic spending. Without a budget, there's no vehicle for tax reform, and without a budget in September, an Oct. 1 shut-down will loom. And let's not forget the debt ceiling increase, a source of huge friction among Republicans.

A CONFUSING ECONOMY: Auto sales may be weak, but overall GDP and employment look good, just not as good as we hoped two months ago; this Friday's jobs report will provide some important clues. Fiscal policy is so muddled that the next Fed rate hike may be a few months away, but there's nothing lurking that would prevent the Fed from beginning its balance sheet reduction in the fourth quarter.

THE MARKETS: They often climb a wall of worry, and there's plenty to worry about. But we'll stick with our mantra that the fundamentals still look remarkably good – moderate GDP growth, a solid labor market, tame inflation, steady interest rates, decent corporate earnings. Trump's theatrics are annoying, but they're essentially background noise. The geopolitical risk is far more serious, and suddenly that's the new factor in the equation.

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