One of Trump's biggest accomplishments could make the next recession worse

Joe Raedle/GettyPresident Donald Trump at a roundtable discussion on Monday about the new Republican tax law.
  • The $US1.5 trillion tax law signed by President Donald Trump last year could worsen the next recession, according to economists and strategists at Morgan Stanley.
  • In a report on Tuesday, they likened the boost from the tax overhaul to a “happy hour” after which the economy would be vulnerable to a painful hangover.
  • Financial markets have already priced in much of the boost from tax cuts, they said.

Enjoy the tax cuts now, but brace for the next time the economy goes bust.

According to Morgan Stanley, the $US1.5 trillion tax law signed by President Donald Trump last year could make the next recession worse than it would have been without the tax cuts.

It’s not all downhill from here: Americans have extra income to spend, and that’s good for them and for the economy.

“But, beyond that, positives become less reliable, and, in our view, downsides are less discussed,” a team of strategists and economists including Michael Zezas said in a note on Tuesday.

“While this policy supports growth in the near term, it may worsen the next downturn while limiting the fiscal reaction to it. Even if those concerns are unfounded, we think much of fiscal stimulus’ ‘good news’ is already in the price of key markets.”

To that end, it’s not really “morning in America,” as Ronald Reagan’s 1984 reelection ad campaign declared. Rather, it’s “happy hour in America,” Morgan Stanley said.

The analysts offered three reasons the US economy was vulnerable to a painful hangover. First, the stock market, a forward-looking gauge of value, already surged some 20% last year as the Tax Cuts and Jobs Act moved closer to Trump’s desk. Bond yields also rose. To Morgan Stanley, this suggests investors have already priced in the benefits of fiscal stimulus.

Their second reason is that many provisions in the tax act are not permanent; for example, personal tax cuts expire in 2025.

And finally, fiscal stimulus was passed when the economy was robust, meaning it may be harder to use the same tool to fight the next downturn. Republicans may find it politically difficult, Morgan Stanley said, to further expand the budget deficit after compromising this time around to pass the biggest tax overhaul in 30 years.

That means investors should factor in the risk that the next recession is not “shallow and short” – an opinion Morgan Stanley says it’s not hearing from many clients.

“We advocate a focus on sector and stock-specific alpha as these late-cycle dynamics portend narrowing markets and a cyclical top for equities later this year, in our view,” the firm said. “In Treasuries, we see the curve continuing to flatten on Fed hikes, and yield downside as the year progresses and the economic outlook becomes more mixed.”

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