In the immediate aftermath of the November election investors dared to hope that the U.S. had entered a new political era. The market reaction -- or lack of it -- to Donald Trump's sketchy plan for tax cuts on Wednesday is part of a recognition that Washington remains stuck with politics as usual.
On the face of it the tax plan is exactly what investors put so much hope in back in November. It would cut the corporate tax rate to 15%, from the current effective rate of 28%, putting many billions of dollars into shareholders' pockets every year. The plan isn't detailed enough to be precise about the effects on the budget, but it would boost debt by trillions of dollars over the next decade, presumably juicing the economy along the way. In a sweet move for Wall Street, hedge-fund managers would get a tax cut, not the tax rise Mr. Trump threatened during the election campaign.
The hyped-up tax plan disappointed investors not because of what it contained, but because of the prospects of it being implemented. The White House seems to have made little effort to appeal to Democrats and none at all to make the plan acceptable Republican deficit hawks. The plan will be weakened as Congress gets its teeth into it, and the tough negotiations remain in the future.
Yet the disappointment was contained. The S&P 500 dropped just 0.4% after the plan was revealed, a fall repeated in Europe on Thursday morning. Given the S&P had been almost touching its record from the start of March, the fall is minor. The smaller-company Russell 2000 index -- which should be a big beneficiary of any corporate tax cut -- fell by less, while typically in a falling market it drops faster. The dollar pulled back about 0.3% after the announcement against a basket of major developed currencies, well within the bounds of normal daily swings.
The tax plan fits the pattern of pronouncements during Mr. Trump's first 98 days: the president has forgotten Teddy Roosevelt's advice to speak softly and carry a big stick, and is doing precisely the opposite. Reality hasn't lived up to the hype in foreign policy, trade, health care, currency policy or, in part thanks to poor drafting and ornery judges, immigration.
None of this means Mr. Trump's policy agenda is dead, or that he will continue to over-promise and under-deliver. The problem is that trade and diplomacy are where Mr. Trump has the least constraints from Congress and the courts, and it is his promises on trade and diplomacy that scare investors the most.
Investor concern about Mr. Trump using his executive powers was on show in Wednesday's trading. Leaks that the White House was preparing an executive order ditching the North American Free Trade Agreement knocked 1.5% off the value of the Mexican peso in minutes, hurt U.S. stocks and pushed down Treasury yields. The drop in the peso was particularly significant, although entirely reversed later in the day when Mr. Trump reassured Mexico and Canada that the U.S. wouldn't pull out.
Business as usual in Washington means drawn-out negotiations and compromises, and the policy reality rarely matches the political rhetoric. But it is still entirely reasonable to expect something to emerge, later and smaller than investors first hoped, but still significant.
For now it looks as though markets have adjusted their expectations, and are discounting Mr. Trump's hype. The risk of investor disappointment in the months ahead has been reduced, just so long as something passes on tax and Mr. Trump resists the urge to act aggressively where he can.
Write to James Mackintosh at James.Mackintosh@wsj.com
(END) Dow Jones Newswires
April 27, 2017 11:06 ET (15:06 GMT)