Epic Stimulus Overload

Doug Nolan

Ten-year Treasury yields jumped 13 bps this week to 2.48%, the high going back to March. German bund yields rose 12 bps to 0.42%. U.S. equities have been reveling in tax reform exuberance. Bonds not so much. With unemployment at an almost 17-year low 4.1%, bond investors have so far retained incredible faith in global central bankers and the disinflation thesis.

Between tax legislation and cryptocurrencies, there’s been little interest in much else. As for tax cuts, it’s an inopportune juncture in the cycle for aggressive fiscal stimulus. And for major corporate tax reduction more specifically, with boom-time earnings and the loosest Credit conditions imaginable, it’s Epic Stimulus Overload. History will look back at this week - ebullient Republicans sharing the podium and cryptocurrency/blockchain trading madness - and ponder how things got so crazy.

From my analytical vantage point, the nation’s housing markets have been about the only thing holding the U.S. economy back from full-fledged overheated status. Sales have been solid and price inflation steady. While construction has recovered significantly from the 2009/2010 trough, housing starts remain at about 60% of 2004-2005 period peak levels. It takes some time for residential construction to attain take-off momentum. Well, liftoff may have finally arrived. As long as mortgage rates remain so low, we should expect ongoing housing upside surprises. An already strong inflationary bias is starting to Bubble. Is the Fed paying attention?

December 22 – Reuters: “Sales of new U.S. single-family homes unexpectedly rose in November, hitting their highest level in more than 10 years, driven by robust demand across the country. The Commerce Department said… new home sales jumped 17.5% to a seasonally adjusted annual rate of 733,000 units last month. That was the highest level since July 2007… New home sales surged 26.6% from a year ago.”
And from Bloomberg’s Shobhana Chandra: “…The number of [new] properties sold in which construction hadn’t yet started increased almost 43% to 258,000 in November, the most since December 2006… Supply of homes at current sales rate fell to 4.6 months from 5.4 months.”

December 20 - Bloomberg (Shobhana Chandra): “Sales of previously owned U.S. homes rose in November to an almost 11-year high, indicating demand picked up momentum heading into the end of the year… The results show broad strength, with particular firmness in the upper-end market where inventory conditions are ‘markedly better,’ the group said. Forty-four percent of homes sold in November were on the market for less than a month. At the current pace, it would take 3.4 months to sell the homes on the market, the lowest in records to 1999 and down from 3.9 months in the prior month.”

December 19 – Bloomberg (Sho Chandra): “Groundbreaking on single-family homes proceeded in November at the strongest pace in a decade, driving U.S. housing starts to a faster-than-estimated rate… Single-family starts jumped 5.3% to 930,000, highest since Sept. 2007; South and West regions also were 10-year highs. The latest results make it more likely that residential construction spending -- which subtracted from economic growth in the second and third quarters -- will add to the pace of U.S. expansion in the October-December period, which is already shaping up as a solid quarter.”

U.S. and global growth surprised on the upside in 2017, explained by monetary conditions that somehow became only more extraordinarily loose. The Fed, with its dovish approach to three baby-step hikes, failed to tighten conditions. Led by the Bank of Japan and the European Central Bank, it was another year of massive global QE. Meanwhile, Chinese “tightening” measures couldn’t restrain record Credit growth. At the “periphery,” EM were the recipients of huge financial flows, spurring domestic Credit systems and economies around the globe. It’s been a huge year for Credit on a global basis.

December 19 – Financial Times (Eric Platt and Robin Wigglesworth): “A borrowing binge by companies and governments has reached a new high this year, providing bumper fees for Wall Street but raising questions ahead of a year of expected tightening of cheap money by the world’s most important central banks in 2018. Blue-chip corporate borrowers such as AT&T and Microsoft have led the way, as companies accounted for more than 55% of the $6.8tn raised in 2017 through bond sales organised by banks, according to… Dealogic. Countries from Argentina to Saudi Arabia also took advantage of an almost decade of low interest rates in developed economies, which forced investors to chase returns in the bonds of emerging market governments and their companies. ‘In 2017, there was such an influx of capital coming into high-quality fixed income. It’s a demand-fuelled story,’ said Gene Tannuzzo, a portfolio manager with Columbia Threadneedle. ‘If you are a sovereign or corporate, with interest rates where they are, you are supposed to borrow now.’”

Bloomberg’s Michael McKee: “Is the bond market telling the President he’s wrong about the potential for increasing the growth rate of the United States.

Federal Reserve Bank of Minneapolis President Neel Kashkari: “Well, I think the bond market is saying a couple things to me. One, inflation expectations are drifting lower. They have drifted lower, and that’s in large part, I believe, because of the Fed – because we’ve been sending these hawkish signals by raising interest rates in a low inflation environment. Second, I think the markets are also pricing in a lower neutral real interest rate. So the interest rate that balances savings and investment in the economy is set by broader economic forces. It’s been trending down over the last few decades. I think markets are embracing that concept and pricing in a lower, what we call “r-star”, which then caps where bond yields are, and at the same time can explain some of the appreciation in the equities markets, as they’re discounting cash flows at a lower rate. So those are the signals that I take away from the bond market right now.

Bloomberg’s David Westin: “…If you had your way, if you went from what the Fed is predicting now - three [rate] increases next year - to one, or maybe none, what would happen to the long-end of the yield curve, in your view?”

Kashkari: “In my view, I think that would take off some of the downward – the disinflationary pressure that I think the committee is putting on the long-end of the curve. In my view, by raising rates in a low inflation environment we are sending a signal that our 2% inflation target is not a target. We’re sending a signal that it’s a ceiling – that we’re not going to allow inflation to creep above 2%. And I think that’s putting pressure on the long end of the curve. If you look at how we’ve behaved – not at what we’ve said – we say it’s a target not a ceiling. If you look at how we’ve behaved over the past five or six years, we’ve been treating 2% as a ceiling. I think markets have figured that out and they’re pricing that in. So to me, the Fed is pushing up the front end with our rate increases and pushing down the long end by sending this very hawkish signal about the outlook for inflation.

“Very hawkish signal”? It’s been a while since radical dovishness was an impediment to career advancement at the Federal Reserve (or prospering thereafter). 
 
Central bankers over recent decades have repeatedly found excuses for leaving monetary policy too loose for too long. In the face of history’s greatest expansion of global debt, central bankers have since the early nineties justified loose monetary policy by pointing to deflation risk. When the economy and markets were turning increasingly overheated in the late-nineties, chairman Greenspan claimed a New Paradigm of technological advancement presented the U.S. economy with a faster speed limit. When the post-tech Bubble reflation was spurring record Credit growth and rampant mortgage excess, Dr. Bernanke and others proffered the “global saving glut” thesis. Apparently, it was out of the Fed’s hands.

Now we have a historically low “r-star” “neutral rate” – and Fed hawkishness supposedly pressuring long-term yields lower. I really struggle with the notion that the Fed has been hawkish “over the past five or six years.” Do global central bankers not appreciate that decades of loose finance have been a major force behind disinflationary pressures? Clearly, employing open-ended QE fundamentally altered expectations and market pricing for sovereign debt and long-term financial assets. With myriad Bubbles flourishing around the globe, debt market price in QE forever. I believe global long-term yields would move sharply higher in the event of a stunning outbreak of central bank hawkishness.

December 18 – Wall Street Journal (Michael C. Bender): “Declaring that ‘economic security is national security,’ President Donald Trump aimed to reframe a national debate over his domestic economic and trade policies by thrusting them into a national-security context. ‘Economic vitality, growth and prosperity at home is absolutely necessary for American power and influence abroad,’ Mr. Trump said… as he unveiled his new national security strategy. ‘Any nation that trades away its prosperity for security will end up losing both.’ Recounting a year of stock-market gains and unemployment-rate decreases, Mr. Trump alleged that his predecessors prioritized nation building abroad over economic growth at home. He said his new national security strategy… provided a needed contrast, and included plans for cutting taxes, rebuilding roads and bridges and building a wall along the U.S.-Mexico border.”

December 20 – New York Times (Keith Bradsher): “It’s Xi Jinping’s economy now, and he isn’t too worried about debt. China signaled its economic priorities on Wednesday at the end of a meeting of top Communist Party economic leaders with a statement indicating that President Xi is fully in charge. Labeled ‘Xi Jinping Thought on Socialist Economy With Chinese Characteristics,’ the statement called for trimming industrial overcapacity, controlling the supply of money and other moves that have been staples of China’s other recent declarations. Barely mentioned: China’s surging debt. Despite downgrades this year by two international credit rating firms and warnings from institutions like the International Monetary Fund, the statement issued at the conclusion of the Central Economic Work Conference called for controlling borrowing by local governments, but it otherwise glossed over a vast borrowing splurge in recent years, driven in large part by Chinese companies.”
President Trump is now wedded to the U.S. Bubble. President Xi Jinping is wedded to the Chinese Bubble. I’ve posited a global “Arms Race in Bubbles.” With Trump in charge and the Republicans now pushing through aggressive stimulus, perhaps Chinese officials are rethinking the geopolitical risks associated with efforts to rein in their Bubble excess.

It’s been a long time coming. Yet I wouldn’t be surprised if this week’s jump in yields proves the start of something. Tax cuts coupled with an increasingly overheated economy creates a backdrop conducive to upside inflation surprises. Nice pop in commodities this week. And look at the housing data! And what if Beijing indulges another year of double-digit Credit growth in 2018? And while on the topic of 2018, what are the prospects for the Trump Administration turning its attention to trade competitor China? It’s another campaign promise, and where things could turn really interesting.

For a moment, ponder this: an overheated U.S. economy, a surprising uptick in worker compensation and rising import costs. It’s been awhile since bond investors had to be concerned with anything other than (predictively dovish) monetary policy. “R-star” trending down forever? Remember when the bond market used to intimidate?


The Fed’s James Bullard: The State of the U.S. Economy and What Lies Ahead



St. Louis Federal Reserve Bank president James Bullard joined Wharton finance professor Jeremy Siegel recently, along with Jeremy Schwartz, research director at WisdomTree, for a wide-ranging conversation about the future of interest rates, inflation, the state of the economy, overall monetary policy, the possible over-valuation of stock prices — and more — on “Behind the Markets,” on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.) Bullard oversees the Eighth Federal Reserve District, which includes all of Arkansas and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee.

Edited excerpts of the conversation follow.


Jeremy Schwartz: You have this very regime-based view of the world. [In 2016, the St. Louis Fed switched to a regime-based approach for near-term U.S. macroeconomic projections.] … What regime are we in today?

James Bullard: We continue to be in a low interest rate, low inflation regime, and the global aspect is something to keep in mind. Some of the numbers in the U.S. on the growth side do look a little bit better, but I would still say overall we’re in this rather low[-interest-rate] regime.

And that is making me think that the policy rate [federal funds target] is about right where it is, maybe with a little bit of upside risk. But in contrast to some of my colleagues, I would not think that we have to march up considerably higher from where we are now in order to keep unemployment at a low level and to keep inflation under control.

The inflation numbers are low; that’s really been the surprise of 2017. That’s probably not going to improve by the end of the year here. And inflation expectations are running light as well, as measured by the TIPS market [Treasury inflation-protected securities]. I think that’s the situation for monetary policy right now.

On the New Fed Chair

Jeremy Siegel: Next year you are going to be sitting with a new chairman [Jerome Powell]. He’s been a fellow with you on the FOMC (Federal Open Market Committee), the board, you’ve heard his interactions. Tell us a little bit about your impression.

Bullard: Jay Powell has been a great colleague on the FOMC and in the Fed system. Generally since he came on as governor, he rolled up his sleeves, got involved in many issues including regulatory and monetary policy issues, but also including operational issues within the Federal Reserve. That, I think, exposed him to many people all around the system. And certainly my interactions have been very positive. He is a consensus builder, he is a very sharp business person, and has a lot of acumen. So I think he’s got a good future as the Fed chair.

Siegel: Are you at all concerned that he is the first chairman since G. William Miller decades ago that neither has either a Ph.D. or an undergraduate degree in economics?

And I know Charlie Plosser, the former president of the Federal Reserve Bank of Philadelphia. He expressed some concern about that — would he have the depth of understanding of economics, not being trained in that area?

Bullard: First of all, the Fed has lots of expertise both at the board staff and around the FOMC table, and at the Reserve Bank staff. So we have lots of input from professional economists. There will be no shortage of that I think with a Powell chairmanship. I think he’s been at the Fed for about five years or so, so he’s had plenty of experience himself in deciphering all of the arguments that are being made around current monetary policy.

So I think he will be very good. It might be a little bit different than having, let’s say the Princeton professor, Ben Bernanke, as your chair, but different people have different styles and I’m sure he’ll be able to manage very effectively.

Siegel: I think that he was a member of the Carlyle Group, in private equity, and he worked for Dillon Read. He’s not foreign to the capital markets.

Bullard: On that side he’ll have much better knowledge I think than some of our immediate past chairs, where he’s got a depth of experience there that, for all of their success and all of their credentials, Ben Bernanke and Janet Yellen could not bring to the table because they didn’t have that kind of experience.

Siegel: You mentioned Fed staff, and there are some very, very good people there. Then again, of course you could say virtually no one really foresaw the financial crisis. There are a number of people who said, “Are they the people you always want to listen to? Or do you want to have some independence and hear some other voices that might think differently in terms of what’s going to happen to the economy?” How do you feel about that? I mean, would it be more captive than someone like Bernanke to the Fed staff?

Bullard: I’ll just give you my own take on the monetary policy debate. I say it’s a global debate that goes on 24 hours a day, 365 days a year. And so you’re getting input from all kinds of corners of the globe, and certainly from financial markets, the committee itself, the staff itself. But it’s not like it’s in a closed room where you’re not listening to the rest of the world.

You don’t really have to have a perfect alignment of backgrounds in order to get all of that input from all around the world. And I think we do that in some respects. So if you think about the run up to the financial crisis, it’s true that we did not predict the financial crisis, but I think there is some revisionist history that goes on because the housing bubble was a big topic of discussion for several years before it actually came to an abrupt end. And many people were talking about it, both inside and outside financial markets, and in academia.

On U.S. Economic Growth

Schwartz: James, you just said that we have a global discussion, 24 hours a day, 365 days a year. When Yellen talked about it being global concerns, concerns from China impacting U.S. policy, is that something that is increasingly becoming an issue for you, just the global phenomena of low rates around the world, low growth, or scares from China being the driver of U.S. monetary policy? Should it be so global and focused for the U.S.?

Bullard: Well, I just want to caution people. One of the big issues for the Fed is the so-called R-star [sometimes referred to as R*], the real safe rate of interest, or the natural rate of interest in the global economy. And I would say here in the second half of 2017, we’ve got some of the growth numbers looking a little bit better. It looks like it’s tracking estimates for the second half; the third and the fourth quarter together will be maybe 2.75% growth at an annual rate over that time period. So that gets people kind of excited in the U.S., but I just caution them to look at the global situation. We’ve still got negative rates, nominal rates in Europe, far out of the yield-curve. We’ve got negative rates in Japan, far out of the yield-curve.

And you have to wonder if the U.S. can go very far in an environment where the Western world is basically still in negative rates, and will be for a while. Eventually that will probably get unwound but that’s still quite a ways in the future.

Siegel: Going back to that R-star, … that’s the long run rate that the Fed thinks is down to … 2.75%. Jim, I remember a year ago you thought that what we should be at is a little less than one. I don’t think it’s a secret by saying that we know where your dots are on the dot plot. So that does bring a little question. It looks to me that we’re going to have a rate increase of 25 basis points in the December meeting. That’s above your dot, am I right on that?

Bullard: Well, what I have said is that the regime view suggests that you should just take the evidence at face value, and you should not assume that the real rate is going to revert to some mean that existed in the 1980s or 1990s, or 2000s. The evidence is that the one-year ex post, real rate of interest has been declining ever since the 1980s.

And it’s declined a lot, as much as 700-basis points over that time period. And that’s kind of your base rate, or pretty close to your base rate for your Taylor Rule. [Economist John Taylor’s calculation for the appropriate fed funds rate in light of changing economic conditions.] And if something has been on a downward trend for 30 years, it’s probably not wise to predict that all of a sudden it’s going to turn around in the next year or two and start going back up to its mean.

The better way to handle it for policy purposes is just to say, there are somehow forces at work which has kept this rate very low, and we should accept that evidence, and we should assume that those forces are going to continue to be operative over the next two years. Therefore, our benchmark for our Taylor Rule is at a very low level, and then we can correct for gaps and inflation and unemployment from there. But the basic idea is that you shouldn’t assume the mean reversion that many people do, that you’re going to go back some general level of rates that existed pre-crisis.

On a Possible December Hike

Siegel: If you were a voting member, would you vote against a rate hike in December?

Bullard: Well I don’t know, we’ll have to wait until I get to the meeting and look at the data at that time. I have been concerned that with inflation falling below our target this year, farther than we expected, the core, PC [Phillips curve) inflation rate is only 1.3% year-over-year now, and has been falling this year. So I am a little concerned that we’ll send the wrong signal in December by raising the policy rate, and that depresses inflation expectations, and possibly cements in a lower inflation rate over the forecast horizon. And I think that’s maybe a downside of a rate increase in December.

Now, on the other hand, I have said that I am willing to go with data, and growth prospects have been better this fall, and to the extent that you think that extends into 2018, that might be a bullish factor for the U.S. economy. On that I would say that most forecasts that I have seen, even though they have 2.75% or so for the second half of 2017, most forecasters have that declining in 2018 and 2019, back down to something closer to the 2% trend that I’ve been talking about. To the extent that what is going on now is temporary, then that would lean against a rate increase in December for me. So we’ve got many factors to consider here.

On the Effects of Deregulation

Siegel: Some people suggest that even though we haven’t had the infrastructure spending that Trump has promised, and not even tax reform, … that the lower regulations that we have had might be some reason for better optimism on productivity going forward, which we know has been dismally low over the recovery period since the financial crisis. Do you give much weight to that? Or do you think that’s not an important factor?

Bullard: I am somewhat sympathetic to that. I think the deregulatory attitude probably is very different for this administration compared to the last one, and that has made business people far more confident than they were — you can see that in the sentiment surveys — and I think more inclined to invest in planned equipment than they would have been previously. You would think the more capital would improve productivity, and you would get improvements on that score. That process takes a while to play out, so I’ll kind of believe it when I see it.

Siegel: So you don’t think the recent strength, as you said in the second half of the year, which has been a little bit of a surprise on the upside from what was expected, is not due to a regulatory decline, at least at this point?

Bullard: I don’t know if you can draw a straight line, but I am sympathetic to the story. But if you actually look at the evidence I think it’s hard to draw a straight line there. The thing about regulation is that it is a very broad category that spreads across all kinds of different aspects of the economy.

Which rules are we really talking about? Which ones have not changed? Which ones are changing? If they do change, are they changing for the worse, or are they changing for the better, from a productivity standpoint? So those are hard things to measure, and that would take a long time to sort out. But as a general idea I am sympathetic to it, and I think it has improved business confidence.

Schwartz: I am curious how you would even measure the regulation change from your perspective. In our show, we’ve had a few discussions [about seeing signs of a lower regulatory burden, such as] the largest drop in pages in the Federal register this year. I heard last week somebody said 800 different regulations were rolled back. Do you have a quantification of that concept, or it’s just too loose to figure out?

“If the stock market and the Fed see trouble ahead , equity prices are going to decline and the Fed is going to lower rates…. I would not describe that as a Greenspan Put, [but as] good monetary policy.”

Bullard: You have to look at every one of those and ask yourself, was this just a frivolous regulation that caused a lot of paperwork and therefore was unproductive from the perspective of the economy as a whole? Or are you removing a regulation that will come back to bite you later because it was safeguarding against a bad outcome that is now more likely to occur?

That’s a pretty hard judgment to make.

But regardless, the sentiment in the business community has been very positive about it, and it has given them more confidence to invest in their businesses. And you would think that would eventually feed through to better productivity. But we need to wait to see if that actually happens.

On the Taylor Rule

Siegel: Jim, you mentioned the Taylor Rule. … You did work in the 1990s basically describing how the Fed has acted in response to unemployment, inflation, and actually making that response something that perhaps the Fed should follow.

Now that we have a Republican chairman — although we did under Bernanke too, not under Yellen — we know that the Republicans have supported legislation to not force the Fed to adhere to the Taylor Rule, but to explain deviations from it if that should occur. This is something the Federal Reserve has very strongly resisted. Do you think that Powell will also resist it now that it is coming from his own party? Or do you think there might be a different tack here?

Bullard: I don’t want to speak for Jay, and I’m sure he’ll be asked this in his confirmation hearing so he’ll have to decide for himself what he wants to say on that. But speaking for myself, I’ve been pretty supportive of the idea that we should talk to the public in terms of some kind of baseline, which is how I would interpret this, and then why we’re deviating from that baseline. I just think that’s a part of good communication for any central bank, really.

A lot of the debate gets framed around, well, ‘would you have to slavishly follow a particular version of a Taylor Rule?’ I don’t think that is what is being proposed. I think it’s looser than that, but it would guide the discussion in a way that would probably be informative to markets, and to other observers of monetary policy.

So I think it would be a good way to go. And one thing that we’re doing now, and I would like to do more of, is we have included Taylor-type rules in our reports to Congress. I would like to see those reports be quarterly, have a monetary policy report like other central banks do, and then as part of the discussion there, you could talk about various policy rules and what they would recommend, and where the committee is relative to those recommendations. So I think there is a lot of potential to do good things in this area.

Siegel: Let me drill down on this a little bit. Basically, the Taylor Rule depends critically on that R-star. The short-term, real, natural rate of interest. And when you put 2% as he usually did, and as we usually did years ago, and yes, it then says we should be much higher. But given the instability of R-star — something you in fact have been one of the leading spokespersons on the Fed saying that it has fallen, we can’t use the old R-star — I’m a little surprised on the support for a Taylor-sort of rule. Do you think people will know R-star, and be able to be flexible on that issue?

Bullard: Yes. Maybe I’m just so used to it that I think flexibly about this. But it’s true if you tried to be really rigid about it and tried to force the committee to take a prescription, then you might go astray. Because … like any equation there are a lot of assumptions behind it. And the environment could be changing over time that in a way you should be adapting to.

But what is being proposed is that the central banks should explain its deviations from typical Taylor Rules that are used, and I think in my mind it’s easy to explain why we’re deviating, and one of the reasons is because it looks like the safe, real rate of return has fallen consistently over a very long period. Therefore, we should be taking that into account when we’re making monetary policy.

Siegel: But that isn’t something that John Taylor has talked about.

“It appears that the statistical relationship between low unemployment and inflation is very, very small at this point — possibly even zero.”

Bullard: I just want to get one other thought in here about this. The Fed already does this, because you have members — often in their speeches and their public communication — they’ll use various types of Taylor Rules as a proxy for how monetary policy is going to evolve in the future.

I’ll give you examples. Then chair Bernanke gave an entire speech about the run up to the housing crisis, and how he didn’t think the Fed had contributed to the housing crisis through monetary policy, and he used Taylor Rules all through that speech in order to illustrate the kinds of things that were going on at that time.

Chair Yellen also has given very detailed speeches — she even went out to Stanford, to the Hoover Institution where John Taylor is, and gave a whole speech using Taylor Rules and describing current monetary policy in terms of deviation.

So this already goes on anyway. What is being talked about in Congress would codify to some degree that they maybe would like reports that do that and come in that direction because that makes it easier to understand where current monetary policy is relative to a benchmark.

Siegel: Republicans have generally been more critical of the Fed, I would say, than the Democrats over the last decade or so. Obviously you’ve got extremes like Rand Paul who says abolish the Fed, and certainly it is not at all a position of the GOP. Your appointment does not go through Congress, right?

Bullard: That’s correct.

Siegel: You are vetted by the board, which appointments do go through Congress, but all of the bank presidents, of which there are 12, although only five are voting at any one time, are picked by their board, a board of directors of the regional bank, and then approved by the Board of Governors without a Congressional approval. The Board of Governors in Washington has to be approved before the Senate in hearings. Is this a good structure? Many people are calling for reform — more Congressional oversight, or do you see any way that the current system could or should be improved in that manner?

Bullard: As far as having the presidents of the banks also being presidentially appointed and confirmed by the Senate, I think the main problem with that is that the appointments process has become very cumbersome, and appears to be on the verge of breaking down completely, where it’s very hard to get all of the positions filled.

There is ongoing warfare over this on Capitol Hill, and that, I think, has also led to even the governors’ positions not being filled. We haven’t been at full strength for the number of governors for quite some time. So I think it’s probably not a good time to start thinking about even more appointments that have to be confirmed by the Senate.

Siegel: So you think it is a basically good structure now that should be maintained?

Bullard: I think it has worked very well, and a person like me [has] to get approved by the Board of Governors, which originally occurred when Bernanke was chair. So there is plenty of accountability there, and ultimately the Board of Governors has oversight authority for the system as a whole. You can bring in people certainly with monetary policy perspectives but also with operational expertise to help run the Federal Reserve System. We have done that in recent years, and that is very helpful I think. So I think it actually works pretty well the way it is.

On the Fed’s Mission Creep

Schwartz: Do you think that the Fed is becoming too concerned about markets — if you’re trying to coddle the markets — whether it’s the equity markets, the ‘taper tantrum?’ Some people from the Fed were talking about inequality. Is the Fed going away from its original mission of focusing on employment, inflation and thinking about the markets too much?

“I think we are at a low enough unemployment rate that we actually are …. getting marginal workers back into the workforce.”

Bullard: No, I don’t think so. It is monetary policy, which you might think of as being relatively narrow. But in order to understand the context for monetary policy, you really have to understand the entire economy, and not just the U.S. economy but really the global economy. So that’s why the debate always spills over into very broad issues, and reaches into many quarters that might seem somewhat distant from monetary policy itself.

But at the end of the day we have our regular meetings, and we are making decisions on our policy rate, and on supplemental policies. When we were at the zero bound [zero nominal short-term rates], and so it all does come back home at the end even though the discussion is very wide ranging.

Siegel: I guess during Greenspan’s tenure, there was the discussion of the so-called Greenspan Put, which was if things went bad the Fed would lower rates and rescue the markets. … If the markets tanked for whatever reason, would it put the Fed on pause? Maybe it should. If tanking the markets means there is doubt about the future economy, shouldn’t it be the job of the Fed to pay attention to that?

Bullard: I’ve always felt, on this issue, that it looks like the Fed pays a lot of attention to financial markets, but that isn’t really what’s going on. The Fed is trying to look out for the U.S. economy going forward, and the stock market of course is trying to value corporations by looking at the economy going forward.

So the stock market and the Fed are both looking at the same thing, and if both of them see trouble ahead then the equity prices are going to decline and the Fed is going to lower rates, or have an easier policy than otherwise. But it’s going to be because both entities are seeing trouble ahead. So I would not describe that as a Greenspan Put; I would just describe that as good monetary policy and rational judgment in financial markets about how they see the evolution of corporate profits.

And corporate profits, one thing about that is that most of the traded companies have a lot of their profits overseas. So the profitability often depends importantly on the global macroeconomic situation. Profits have been good recently in part because the global economy doesn’t seem to have any weak spots right now. That has been the first time in quite a few years that you couldn’t point to obvious weak spots in the global economy. That has been helping equity prices this year, and that’s not exactly the same as just having the U.S. economy booming all by itself with the rest of the world maybe not doing as well.

On Low Unemployment and Stock Market Levels

Schwartz: We were talking before on the show on trends in unemployment, which have been dipping down to levels we haven’t seen. We’re getting close to 50-year lows in the unemployment rate and we still haven’t really seen budding inflation pressures, wage pressures. Jim, do you have any sense of how low the unemployment rate is going to go, and is it ever going to lead to wage growth?

Bullard: I think unemployment can trend lower here, but I don’t think that it has much of an impact on the inflation outlook. If you look at Phillips curve estimates, even by advocates of Phillips curve relationships, it appears that the statistical relationship between low unemployment and inflation is very, very small at this point — possibly even zero.

This suggests you could go to … 3.5% or even lower, and you wouldn’t actually see very much inflation — maybe a tenth or a couple of tenths or something like that. And we’re below our target anyway. So I’m not sure that this low unemployment environment is really something to worry about from an inflation perspective. I think you have to make some other kind of argument about it if you’re worried about unemployment going too low.

The other thing is that you’ve got labor force participation, which has been declining since 2000, and I was projecting that labor force participation would continue to decline, but it’s actually flattened out some in the last 18 months or more here.

Siegel: Even longer. Almost three or four years actually flattening.

Bullard: I suppose it depends on how you cut the data there. So I’ve been a little bit surprised on that, but I think we are at a low enough unemployment rate that we actually are starting to attract some people off of the sidelines. You’re getting marginal workers back into the workforce. I think that’s good development for the economy, and with low productivity growth the only way we can get enough output is to have more hours worked.

Siegel: You bring up something really important. We’ve been talking about the natural rate of interest, the long-term dots for the Fed funds projection. We don’t supply those individual dots for the natural rate of unemployment, which is of course another variable you’re asked to do every quarter. Jim, it sounds [like] you are well below what the Fed is now putting up there as the median estimate.

Bullard: We’re below the committee’s median, that’s a fair assessment. But what I am saying is that whatever you want to assume for the natural rate of unemployment, and however big you think that gap is, it still doesn’t have very much of an implication for inflation according to the latest Phillips curve estimate.

Siegel: Shouldn’t it matter at some point for wage increases? We’ll talk about whether they go into inflation, but the concept of tighter labor markets and wage increases, do you think that is the part that is broken? Or it’s coming from the wage increases into the prices that might be the questionable relationship?

Bullard: I have felt that the wage increases — if you go on an ECI [Employment Cost Index] measure — maybe 2.5% per year, have been pretty reasonable. If you think labor productivity is growing at half a percent per year, and the inflation target is 2%, then that comes to 2.5% nominal wage growth, which is about what we’ve seen.

That is all very consistent with the idea that you are at this 2% growth trend, and not too much is going to change, and there isn’t very much going on in terms of cyclical dynamics now because you’re way past the big recession, and all of the cyclical dynamics have settled down. So you are just on this trend growth path, 2% growth, and so wages are increasing the same way they would along a balanced growth path. So that all makes sense as far as I can tell.

Siegel: If productivity was down to a half of a percent, we wouldn’t get even 2% GDP, would we?

Bullard: Well you could say productivity is 1%, but the inflation rate has only averaged 1.5%. That would be another way to get to that 2.5% wage growth. But either way I think it is pretty consistent with what has actually been happening over the last several years.

Bullard: I thought with Jeremy Siegel here we would be talking about the over-valuation of equity prices.

Siegel: I don’t think it’s a bubble. The Fed has said they are high [stock prices], but not that high given the low interest rates. I can see a 20 P/E [price-to-earnings ratio] with a low interest rate structure, and you’re one of the believers that we’re in a low interest rate structure. Do you share my view?

Bullard: I’m sympathetic that we’re okay for now. But I am definitely keeping an eye on it. I think it is an important issue for the Fed in 2018.

lunes, diciembre 25, 2017

THE GLOBAL ECONOMY IN 2018 / PROJECT SYNDICATE

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The Global Economy in 2018

MICHAEL SPENCE

World leaders

HONG KONG – Economists like me are asked a set of recurring questions that might inform the choices of firms, individuals, and institutions in areas like investment, education, and jobs, as well as their policy expectations. In most cases, there is no definitive answer. But, with sufficient information, one can discern trends, in terms of economies, markets, and technology, and make reasonable guesses.

In the developed world, 2017 will likely be recalled as a period of stark contrast, with many economies experiencing growth acceleration, alongside political fragmentation, polarization, and tension, both domestically and internationally. In the long run, it is unlikely that economic performance will be immune to centrifugal political and social forces. Yet, so far, markets and economies have shrugged off political disorder, and the risk of a substantial short-term setback seems relatively small.

The one exception is the United Kingdom, which now faces a messy and divisive Brexit process. Elsewhere in Europe, Germany’s severely weakened chancellor, Angela Merkel, is struggling to forge a coalition government. None of this is good for the UK or the rest of Europe, which desperately needs France and Germany to work together to reform the European Union.

One potential shock that has received much attention relates to monetary tightening. In view of improving economic performance in the developed world, a gradual reversal of aggressively accommodative monetary policy does not appear likely to be a major drag or shock to asset values.

Perhaps the long-awaited upward convergence of economic fundamentals to validate market valuations is within reach.

In Asia, Chinese President Xi Jinping is in a stronger position than ever, suggesting that effective management of imbalances and more consumption- and innovation-driven growth can be expected. India also appears set to sustain its growth and reform momentum. As these economies grow, so will others throughout the region and beyond.

When it comes to technology, especially digital technology, China and the United States seem set to dominate for years to come, as they continue to fund basic research, reaping major benefits when innovations are commercialized. These two countries are also home to the major platforms for economic and social interaction, which benefit from network effects, closure of informational gaps, and, perhaps most important, artificial-intelligence capabilities and applications that use and generate massive sets of valuable data.

Such platforms are not just lucrative on their own; they also produce a host of related opportunities for new business models operating in and around them, in, say, advertising, logistics, and finance. Given this, economies that lack such platforms, such as the EU, are at a disadvantage. Even Latin America has a major innovative domestic e-commerce player (Mercado Libre) and a digital payments system (Mercado Pago).

In mobile online payments systems, China is in the lead. With much of the country’s population having shifted directly from cash to mobile online payments – skipping checks and credit cards – China’s payments systems are robust.

Earlier this month on Singles’ Day, an annual festival of youth-oriented consumption that has become the single largest shopping event in the world, China’s leading online payment platform, Alipay, processed up to 256,000 payments per second, using a robust cloud computing architecture. There is also impressive scope for expanding financial services – from credit assessments to asset management and insurance – on the Alipay platform, and its expansion into other Asian countries via partnerships is well underway.

In the coming years, developed and developing economies will also have to work hard to shift toward more inclusive growth patterns. Here, I anticipate that national governments may take a back seat to businesses, subnational governments, labor unions, and educational and non-profit institutions in driving progress, especially in places hit by political fragmentation and a backlash against the political establishment.

Such fragmentation is likely to intensify. Automation is set to sustain, and even accelerate, change on the demand side of labor markets, in areas ranging from manufacturing and logistics to medicine and law, while supply-side responses will be much slower. As a result, even if workers gain stronger support during structural transitions (in the form of income support and retraining options), labor-market mismatches are likely to grow, sharpening inequality and contributing to further political and social polarization.

Nonetheless, there are reasons to be cautiously optimistic. For starters, there remains a broad consensus across the developed and emerging economies on the desirability of maintaining a relatively open global economy.

The notable exception is the US, though it is unclear at this point whether President Donald Trump’s administration actually intends to retreat from international cooperation, or is merely positioning itself to renegotiate terms that are more favorable to the US. What does seem clear, at least for now, is that the US cannot be counted on to serve as a principal sponsor and architect of the evolving rules-based global system for fairly managing interdependence.

The situation is similar with regard to mitigating climate change. The US is now the only country that is not committed to the Paris climate agreement, which has held despite the Trump administration’s withdrawal. Even within the US, cities, states, and businesses, as well as a host of civil-society organizations, have signaled a credible commitment to fulfilling America’s climate obligations, with or without the federal government.

Still, the world has a long way to go, as its dependence on coal remains high. The Financial Times reports that peak demand for coal in India will come in about ten years, with modest growth between now and then. While there is upside potential in this scenario, depending on more rapid cost reductions in green energy, the world is still years away from negative growth in carbon dioxide emissions.

All of this suggests that the global economy will confront serious challenges in the months and years ahead. And looming in the background is a mountain of debt that makes markets nervous and increases the system’s vulnerability to destabilizing shocks. Yet the baseline scenario in the short run seems to be one of continuity. Economic power and influence will continue to shift from west to east, without any sudden change in the pattern of job, income, political, and social polarization, primarily in the developed countries, and with no obvious convulsions on the horizon.


Michael Spence, a Nobel laureate in economics, is Professor of Economics at NYU’s Stern School of Business, Distinguished Visiting Fellow at the Council on Foreign Relations, Senior Fellow at the Hoover Institution at Stanford University, Advisory Board Co-Chair of the Asia Global Institute in Hong Kong, and Chair of the World Economic Forum Global Agenda Council on New Growth Models. He was the chairman of the independent Commission on Growth and Development, an international body that from 2006-2010 analyzed opportunities for global economic growth, and is the author of The Next Convergence – The Future of Economic Growth in a Multispeed World.


Here's My Biggest Worry For 2018

by: The Heisenberg

 

- Lots of folks are asking for Heisenberg's 2018 Outlook.

- So I'm going to give you my riff on a year-ahead piece which, true to form, will not fit any mold.

- Long story short, I hope I'm proven wrong.
 
 
 
In what I assume is a testament to my penchant for skepticism and in some cases, outright cynicism, I've received quite a bit of e-mail recently asking what I'm most "worried about" going into 2018.
 
First of all, the easy answer to that is simply this: "nothing that you're going to care about." On that, humor me for a (very) brief tangent.
 
The "worry" question gets posed every year to anyone who comments on markets with any regularity.
 
When the question comes from individual readers or clients (as opposed to from media outlets that are looking to publish year-ahead pieces), it's almost always presented in a way that suggests the person doing the asking assumes that something market-related is going to be on the top of the commentator's "worries" list. That's an absurd assumption. That is, if what you really want to know is "what I'm most worried about in 2018", I can promise you that nowhere in the top five is anything to do with markets. That doesn't mean I don't live and breathe markets to a degree that might very fairly be described as "unhealthy", it just means that if you were to get a hold of my top five worries list for the coming year, you'd find things like "devastating hurricane wipes out the Heisenberg beach bungalow" not "VaR shock dents multi-asset portfolios."
 
Incidentally, the devastating hurricane worry has very nearly been realized three times in the past two years.
 
Ok, moving past that tangent (i.e., assuming we're talking specifically about the market context), what I'm most concerned about headed into 2018 is retail investor psychology, and in the same vein, I'm worried about what the ramifications of a bungled exit from central bank stimulus will be for well-meaning popular pundits. Regular readers will recognize this theme as it pervades a lot of what I write.

The difference between me and the people I'm often compared to is that I've actually been in some dicey situations in my time and without elaborating, suffice to say I can spot malice a mile away. So very much unlike a lot of market skeptics and so-called "permabears", I do not think that central bankers have a nefarious master plan and I do not think that the popular pundits you might follow on Twitter or see everyday on CNBC are trying to deceive you.
 
Rather, what's happened over the last nine or so years is that policymakers have been forced into a situation where they cannot publicly acknowledge the extent to which ZIRP, NIRP and QE have inflated bubbles in financial assets because doing so might well destabilize markets.
 
That's not "dishonest." It's just common sense. You're not going to deliberately do something that could trigger a meltdown.
 
Obviously, the Fed, the ECB, and the BoJ are acutely aware that flooding the market with $15 trillion in liquidity via massive purchases of government bonds, corporate bonds, and equities has driven up asset prices. After all, they explicitly set out to create a hunt for yield (just ask Ben Bernanke). These asset purchases by definition distort supply/demand by engineering a shortage of purchasable assets (supply) and compressing risk premia (demand, as that creates voracious appetite for anything with a positive yield). What happened here is that they assumed the transmission mechanism from monetary policy to the real economy was more efficient than it actually is. In other words, it has taken a lot longer than they anticipated to create a synchronized upturn in global growth and they still aren't there on the inflation targets.
 
(Goldman)
 
 
See what I mean? We're just now (i.e., after eight years of stimulus) seeing a synchronized global recovery (left pane) and we're still well short of the inflation targets across DM economies (right pane).
 
They were pot-committed to seeing this through a long time ago, so they effectively had to persist until they "won" at least one battle (i.e., either growth or inflation). All the while, stimulus continued to inflate financial assets. The proliferation of low-cost ETFs supercharged the dynamic by giving retail investors easy access to every corner of the market be it something as simple as the S&P (SPY) or something that was previously esoteric for mom and pop like junk bonds (HYG). Those flows were encouraged as asset prices continued to rise on the back of stimulus and thus the "wave paradox" was born. Investors are no longer sure whether the decisions they're making are good or whether the decisions they're making only turned out good by virtue of their having made them.
 
Popular pundits have gotten swept up in this. They don't understand it. Which is a tragedy because in many cases they have access to the research they would need to get a handle on it.
 
Let me give you two actual, real-life examples from Twitter exchanges I've had with two widely-followed names this month. I'm going to remove the names here because the point is certainly not to malign anyone, rather the point is to reinforce the idea that the people the public relies on the covey financial wisdom don't grasp the dynamic.
 
Ok, here's the first one:
 
 
 
So that's a chart of the Dow and a chart of General Electric (NYSE:GE), and as you can see, the contention there is that because the Dow is up and GE is down over an arbitrary time frame, indiscriminate flows from passive investing are not supercharging the market rally.

For one thing, the tweet there makes no sense. This (very popular) personality is essentially saying that indiscriminate flows are not indiscriminate. Indexing is indiscriminate. There's no question about it. Even if you want to split hairs, there is no world in which indexing is not at least in some sense indiscriminate. What does indexing even mean if there's not an indiscriminate element to it?
 
But beyond that, the logical fallacy there is so blatant that I had a hard time figuring out how to communicate the inherent absurdity. Of course, it's me we're talking about, so you can bet your bottom dollar I found a way. To wit:
 
 
 
Again, the problem here is that this person has something like 950,000 Twitter followers who depend on him for accurate information and there is absolutely nothing accurate about what's implied in the first tweet shown above. And it's not harmless. Far from it. It serves to make retail investors think that there's no merit to the idea that indexing, by virtue of its indiscriminate character, is creating distortions. It unquestionably is. Just ask Howard Marks or Goldman or Arik Ahitov and Dennis Bryan or Wells Fargo or any of the other countless examples I'll be happy to send you if you care to e-mail me.
 
Let's move on to the second example. Here's the initial tweet (and this is from a different popular pundit):
 
 
 
And here is my initial response:
 
 
 
That kicked off a lengthy exchange between the pundit and followers. I didn't participate much further, but I did offer the following chart which plots rolling central bank asset purchases against HY spreads:
 


Unfortunately, the pundit in question decided to respond as follows:

 
 
 
Got that? Citi deliberately started the chart in 2010 "because it would totally break down before that."
 
Because I am actually a much nicer person than I'm given credit for, I didn't have the heart to show him the following two charts which, while slightly different (they plot 12-month rolling change in global central bank liquidity versus IG credit and global equities), completely refute that commentator's "chart crime" contention:
 
(Citi)
 
 
As you can see, those charts start in 2009. There is no "chart crime." There is just a popular pundit who doesn't seem to grasp what's going on and the truly strange thing about the contention that it's a "chart crime" to plot global central bank purchases against spreads starting in 2010 is that the global plunge into QE started in 2009, so I'm not sure what this person expects. That is, if what we're talking about is post crisis monetary policy's effect on global assets, what kind of sense would it make to use charts that date to before those policies were implemented?

Those are two rather poignant examples that illustrate why I'm worried about retail investor psychology and about what the ramifications of a bungled exit from central bank stimulus will be for well-meaning popular pundits.
 
When it becomes apparent (and it will) that this tsunami of liquidity and constant policymaker communication with markets were together the proximate cause of the rally in global financial assets, there is going to be a crisis of confidence among retail investors. They're going to lose confidence in themselves because they will realize that a decade's worth of gains were engineered, they're going to lose confidence in popular pundits who have taken it upon themselves to keep the investing public informed, and perhaps most importantly, they're going to lose confidence in policymakers if those policymakers do not manage to pull off an orderly exit from the post-crisis policy regime.
 
One reason this is particularly concerning to me is that losing confidence in oneself and in well-meaning pundits and policymakers is something completely different from being angry at a group of people you already suspected of being inherently shady in the first place. After 2008, the blame was placed squarely on the shoulders of Wall Street, and while that shook confidence in the nation's financial system, Main Street distrusting Wall Street was hardly a new phenomenon.
 
To be sure, investors profess to be skeptical of the punditry. But look how many likes and retweets the chart of the Fed balance sheet and the S&P shown above received. That represents (at least in part) trust in the personality who tweeted that highly dubious graph. Do note that the reason it's dubious has everything to do with the caption. That is, the chart is just the chart. It's the caption that's misleading. In the same vein, the personality that tweeted the GE/Dow chart is the single-most followed pundit on FinTwit (for those who aren't up on the lingo, "FinTwit" is just shorthand for the finance Twitter "community"). So feigned skepticism of the punditry aside, these folks are widely respected as something akin to authorities on these matters. Obviously, there are countless examples of people who fall into the same category.

Finally, one could argue that distrust in policymakers is not only not new, but is in fact endemic in America. That would be true of politicians. And as much as you and I (i.e., people who enjoy talking about markets) might have reservations about the collective wisdom of central bankers, the vast majority of the stock-holding public couldn't tell you the first thing about the Fed and I think it's entirely reasonable to suggest that most people who have a 401k wouldn't be able to tell you what the acronyms "ECB" and/or "BoJ" even stand for. Now imagine trying to communicate to those people how a few missteps on the way to exiting something called "quantitative easing" ended up accidentally sinking their passive portfolio. If you thought people were confused about how CDOs and MBS tanked the market in 2008, just wait until someone tries to explain to them how QE works.
 
Let's leave aside the obvious near to medium term implications for markets (e.g., panic selling when everyone scrambles to figure out how an errant bit of overly aggressive forward guidance triggered a rates tantrum that spilled over into equities and, further, why that should even matter if QE wasn't behind the rally as all the pundits claimed). The bigger question is what kind of longer-term psychological impact this will have on retail investors and on pundits who I firmly believe are well-meaning and who are in fact far more concerned about your financial well-being than Heisenberg, with the only issue being they don't seem to know what they're talking about.
 
We do not need another mass crisis of confidence triggered by the unwind of the very policies that were instituted to calm everyone down after the previous crisis of confidence.
 
Coming full circle, how truly "worried" about this is Heisenberg? Well, in the grand scheme of things, not very. America's capital markets are deep and highly liquid (liquidity problems stem not so much from the markets themselves, but from policy and from "innovations" that have altered market structure). Additionally, it seems unlikely that policymakers wouldn't step in to ensure that the bottom doesn't fall out as a result of their inability to rollback stimulus. That's the spiraling bubble dynamic whereby the policy response to each burst bubble must be large enough to create a new bubble big enough to subsume the last one. Theoretically, that can go on in perpetuity. Lastly, I have a lot of faith in the resiliency of the system in general and I do not believe that there is any chance that creative destruction will ever be allowed to take hold - central banks will literally send everyone checks in the mail before they let the soup lines start forming.

But what does concern me slightly (and I'm a selfish guy, so I do mean "slightly") is the prospect that I'll be proven right. Contrary to popular belief, I have absolutely no desire to see retail investors experience the mental shock that would come with discovering that a series of policies which the masses have been assured aren't the sole source of market gains are in fact the proximate cause for those gains. I'd much rather see central banks stick the proverbial dismount from the policy balance beam so that no one is the wiser.
 
In the meantime, do note that the historical anomalies are adding up. As BofAML recently pointed out, US equity trading ranges hit 110-year lows in 2017:
 
(BofAML)
 
 
And the buy-the-dip mentality is manifesting itself in all sorts of ways (take a second to read the captions on the following charts - they are self-explanatory):
 
(BofAML)
 
 
Overall, this is what the landscape looks like from a 30,000-foot perspective:
 
 
 
One way or another, that has to break.
 
There's my 2018 outlook. Hopefully, it lived up to your expectations, whether they were high or low.


Feature

It’s Official: What the New Tax Bill Means for You

By Karen Hube   

It’s Official: What the New Tax Bill Means for You
Photo: Getty Images


The Tax Cuts and Jobs Act, passed by Congress today and about to be signed into law by President Donald Trump in the next day or so, is a major coup for U.S. corporations, but a mixed bag of give-and-take for individual taxpayers, with benefits sharply skewed to the wealthy.

The top corporate tax rate, which affects publicly-traded companies, will drop from 35%—one of the highest top rates levied by developed nations—to 21% in 2018. The move is roundly applauded as a necessary step to keep U.S. multinational businesses competitive with foreign companies.

But to pay for the corporate tax cut, the final bill reneges on many of its original objectives that would have benefited individual wage earners. President Trump promised tax reform that would simplify the tax code, focus tax relief on working families, and close loopholes for wealthy taxpayers and businesses. But the bill, cobbled together frenetically in closed-door cram sessions by Republicans eager to get a major legislative victory on the books before year end, does none of those things.

“Instead it is more complicated, creates more loopholes for special interests and is more unfair to the middle class than current tax rules,” says Steve Wamhoff, a senior fellow for income tax policy at the Institute on Taxation and Economic Policy, a nonpartisan think tank in Washington, D.C.

Most taxpayers will see their tax burdens decline and their after-tax income rise in 2019, after the new law is fully in effect. But the “Christmas gift to the American people,” as President Trump characterized the tax bill, is disproportionately puny for lower-income folks compared with high net worth taxpayers. While more than $300 billion in tax relief will go into effect in 2018, more than half of the benefits of the bill go to the richest 5% of taxpayers, and a quarter goes to the richest 1%.

The lowest-income quintile of taxpayers earning less than $25,000 annually should count on keeping an extra $90 a year in their pockets under the tax cut—a 0.4% bump in their after-tax income, according to the Tax Policy Center in Washington, D.C. Middle-income families earning $49,000 to $86,000 annually should expect an average tax cut of $900, increasing their after-tax income by 1.6%. Folks with incomes between $308,000 and $733,000 will see an average 4.1% improvement thanks to an average $13,500 cut; and those in the top 1%, with income of more $733,000, are in for an average $51,000 tax reduction, which should plump up after-tax income by 3.4%.

The bill maintains seven tax brackets, but reduces income tax rates for just about every taxpayer, with the top rate dropping from 39.6 % to 37%. Many currently in the top tax bracket will see their top rate drop to the second-highest tax rate of 35%, because the threshold for income taxed at the top rate has been raised from $470,701 for married couples filing jointly to $600,000.

But new limits on deductions offset the full benefit of the tax rate reductions. Most notable: A $10,000 cap on deductions for state and local income taxes and property taxes, combined. Under current law, state and local income taxes and property taxes are fully deductible on federal returns.

This hits hardest in high-tax states. Among the highest: California, New York, New Jersey, Oregon, Minnesota, Iowa and Vermont.

The bill also lowers the allowable mortgage interest deduction and scraps home equity interest deductions. Currently taxpayers can deduct interest on mortgages of up to $1 million. Effective for home purchase Dec. 15, of this year, that cap is now $750,000. The $1 million cap remains for existing homes.

Nationwide, the impact of the limit on mortgage deductions seems minimal. Only 3.5% of homes sold this year had mortgages of more than $750,000, according to Attom Data Solutions, a real estate research firm in Irvine, Calif. But put the spotlight on some high-cost areas of the country and the impact looks far different: In New York City, 64% of new mortgages are valued over $750,000, and in San Francisco, 58%.

“Concern is that we’ll see fewer sales of existing homes because homeowners won’t move if they don’t get the deductions they want on a new mortgage,” says Dan North, chief economist at Euler Hermes North America in Baltimore, Md. “This could mean a drop in home values.”

A welcome change is to the alternative minimum tax. Exemptions have been raised from $84,500 for couples filing jointly to $109,400, and the phase-out income threshold for the exemption has been raised from $160,900 for couple to $1 million.

A more controversial measure is the scrapping of personal exemptions, currently $4,050 per family member. In an attempt to offset this, the standard deduction has been raised to from $6,350 for singles and $12,700 for couples filing jointly to $12,000 and $24,000.

In addition, the child tax credit has been doubled, from $1,000 to $2,000, and income limits on who may claim the credit have been substantially increased, from $75,000 for singles and $110,000 for couples to $200,000 and $400,000. Under threat by Senator Marco Rubio to oppose the bill, lawmakers also raised the refundable amount to $1,400 when the credit is larger than income tax liability.

How well the standard deduction and child tax credit increases counterbalance the loss of the personal exemption depends on family size and whether a family itemizes deductions.

This year, a family of four earning, say, $300,000 will get a $28,900 in combined standard deduction and personal exemptions, assuming they don’t itemize. If they do, their total would be higher. The family doesn’t qualify for the child tax credit.

Under the new law, the family qualifies for the child tax credit and would likely take the standard deduction, because it will be so much higher, but the personal exemptions fall away.

The total benefit drops to $28,000.

For a family of six at that income level, this year the benefit would be $35,700; under the new bill it will drop to $32,000.

Ultimately, how the bill shakes out for each individual or family depends on income and wealth level, family size, what state you live in and whether you own a home, among other factors.

Tim Steffen, director of advanced planning at Baird Private Wealth Management, ran various tax analyses for different hypothetical families around the country to understand the tax impact of the new law. He assumed incomes ranging from $100,000 to $1 million a year, and high tax, low tax and no income tax states.

In most cases, he says, the lower tax rates outweigh the disadvantage of the trimmed deductions under the new law.

At income levels of $100,000 and $500,000, his hypothetical families had the same federal tax burden regardless of whether they lived in a high, low or no-tax state. That’s because the cap on state property and income tax deductions equalizes their situations.

Families in high-tax states get the lowest tax savings under the bill, because under current law they are paying the lowest federal taxes due to their large state income and property tax deductions, so they feel the loss of those deductions the hardest.

At the $1 million income level, the loss of state tax deductions is more likely to cause an increase in tax burden, according to Steffen’s analysis. Consider a family of four in Westchester County, N.Y., a New York City suburb, with a $2 million home, a mortgage balance of $1.2 million, a state tax bill of $67,000, and a $40,000 property tax.

Based on those and other assumptions, the family’s federal tax would be $275,675 this year, and $276,079 next year.

If the same family were based in Hillsborough County, Fla., where there is no state income tax, this year its federal liability would be $308,579. Under the new tax bill, it would drop significantly, to $276,079.

Generally, under the new plan, the greater the income and wealth levels, the greater the total tax savings. For most wealthy families, you have to look beyond just income taxes to understand their full benefit, says Matt Gardner, a senior fellow at the Institute on Taxation and Economic Policy.

The estate tax, while still in effect under the new bill, will kick in at much higher income levels thanks to a doubling of the exemption from the current $5.49 million for individuals to $10.98 million. Couples will be able to shelter $21.96 million from the estate tax.

Most owners of pass-through entities such as S corps and limited liability companies will see a much-welcome 20% deduction on income. While this will be welcome for small operating businesses, two-thirds of pass-through entities are owned by the top percentile of taxpayers, “so this is the equivalent of giving a big tax break to the wealthy,” Gardner says.

The benefits to most individual taxpayers are scheduled to expire in 2025—a strategy put in place to keep the cost of the bill below a $1.5 trillion threshold to enable, under congressional rules, Republicans to push the bill through without a so-called simple majority, in this case meaning they didn’t have to rely on support from Democrats.

Wealthy taxpayers, meanwhile, are expected to continue to benefit from the only major permanent provision under the bill—the reduction in the corporate tax rate. Most shareholder wealth is concentrated among the wealthy, and as corporations benefit from their lower tax burden, so, too, will shareholders in the form of higher dividends and rising stock prices.

While Republicans claim the benefit to corporations will ultimately trickle down to the working class through pay raises and job expansion, many economists are dubious, as this hasn’t been borne out in history.

For now, some year-end moves could save some taxpayers a bundle. Consider, for example, prepaying any 2017 state taxes that you would normally push into 2018.

Many taxpayers underpay state and local taxes in a given calendar year due to under-withholding, and make their final payments in the next year by the April 15 tax-filing deadline. And for those who file estimated quarterly taxes, their fourth-quarter tax payment isn’t due till January of the following year.

Usually, taxpayers prefer to hold off paying taxes until necessary. “But prepaying is a way to take advantage of state tax deductions, which are going away next year,” says Lisa Featherngill, managing director of wealth planning at Abbot Downing.

For folks paying the alternative minimum tax, typically those earning between $200,000 and $500,000, this is a moot point because they don’t get the benefit of the state tax deduction anyway. “Have your accountant run the numbers,” Featherngill advises.

Another tax-saving move: With the standard deduction raised to $24,000, many folks will take the standard deduction rather than itemize. Taxpayers itemize their deductions when total deductions exceed the standard deduction.

“Figure someone who doesn’t have a mortgage will be taking the annual maximum allowable $10,000 deduction for state and local taxes next year, and makes a $10,000 yearly charitable gift. They’d have $20,000 in deductions, which means they’d take the standard deduction,” Featherngill says. “That deduction for the charitable contribution would be lost.”

So consider clustering those planned future $10,000 gifts into 2017. That’s an extra $50,000 deduction this year, compared with no tax benefit for the gifts if they were spread over future years.

Most planning opportunities will be next year. The new estate tax exemption will prompt a flurry of estate plan revisions, and the change in tax rates on businesses warrants a hard look at how wealth is structured.

“We’re going to see pass-through owners asking if they should be structured as C corporations to take advantage of the new top 21% tax rate,” says Jim Wilhelm, director of SC&H Group, a tax consulting firm in Glencoe, Md. Pass-through income is taxed at income tax rates, up to 37% under the new law.

Aside from the lower tax rate, corporations can deduct state and local taxes under new rules, while pass-throughs can’t.

Folks subject to income tax rates with flexibility on how they claim their income will inevitably explore creating a pass-through entity to pay out their income, so they can get that new 20% deduction.

The varying new benefits and rates on individual, pass-through and corporate income set the stage for years of scheming and mining through the tax code for new ways to game the system, Wilhelm says. Without the simplification of the tax code, it’s a different set of rules, but the same game.