US tax cuts and dollar, an oil mystery and the Bank of England vote

Here are the big questions the FT Markets team are asking this week.

What would US tax cuts do to the dollar and bond yields?

Back when Republican control of both houses of Congress, and the presidency, empowered dreams of long-awaited legislation, repealing Obamacare was the first step towards a radical rethink of the US tax code. Procedural tactics, and rules for new legislation to do with their impact on the deficit over time, meant that sweeping change (and big tax cuts) required repeal of the Affordable Care Act.

So, instead of a 15 per cent corporate tax rate, immediate deductibility for capital spending, a dollar repatriation scheme and a border adjustment tax, the party of Reagan may instead lower its ambitions to give Donald Trump a “win”.

The impact of straightforward giveaways could produce competing impulses. Bond investors may see a bigger government deficit and a spur to growth. Higher Treasury yields would be a natural response.

Yet would that be good or bad for the dollar? Markets tend to be moved by expectations, and the greenback has dropped 10 per cent this year as the reality of Republican political dominance has unfolded. Higher yields would attract capital, but they also hurt foreign investors whose purchases helped propel the dollar higher in recent years, just as the Federal Reserve stops reinvesting its holdings of debt. Higher yields and a softer dollar could go hand in hand.

A summer quirk, or is something deeper happening in the oil market?

For the past three years one of the clearest financial measures of the oil glut has been spot prices trading far below contracts for delivery in the future.

This market structure, known as contango, is indicative of a surplus of immediate supplies. While the situation makes it relatively easy for big oil companies with access to large-scale storage to make money by buying and holding crude, it is seen as bearish for the overall outlook.

But in the past few weeks, with summer maintenance cutting output in the North Sea and Opec making additional efforts to tighten the market, Brent crude oil’s contango has all but disappeared, at least between the front and second month contracts.

This has been accompanied by a recovery in the spot price of Brent to almost $52 a barrel, the highest in almost two months.

Oil traders will be watching closely to see if it continues, but if the market starts to move into backwardation across the curve — the opposite of contango — it would be the strongest sign yet the glut really is coming down.

How will the Bank of England vote?

Hawks can catch hares, but in June they set one running when the UK committee which sets interest rates voted 5-3 to keep them at 0.25 per cent. The unexpectedly close vote started a month of speculation about the approach of the Bank of England to inflation overshooting its 2 per cent target, feeding a narrative that policymakers around the world were in sudden agreement about plans to reduce stimulus measures.

Yet expectations have shifted again in response to what economists at Bank of America Merrill Lynch call “a smorgasbord of soft data”. Gilles Moec says “inflation should peak soon, manufacturing output is flat as a pancake, like retail sales, so GDP growth in the first half of 2017 was the weakest for four years.”

Anything other than 6-2 for stasis would be a surprise, meaning tighter monetary policy will again be postponed. Bond markets may have to focus on 2019, when Brexit negotiations are due to conclude.

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