Why the GOP tax reform plan could push the Fed into more rate hikes

Joshua Roberts | Reuters

Federal Reserve Board Chairwoman Janet Yellen speak during a news conference after the Fed releases its monetary policy decisions in Washington, U.S., June 14, 2017.

The White House has indicated that it will not waver from a pledge to cut the corporate income tax from 35 percent to 20 percent. In addition, the plan reduces the number of tax brackets from seven to three, cutting the top rate from 39.2 percent to 35 percent and doubling the standard deduction for income tax filers, raising the so-called zero bracket to $24,000.

Critics already have pounced on the plan as a giveaway to the rich that does little for lower-income brackets. However, expectations are rising that the Republicans will accomplish at least some level of tax cuts or reform before the midterm elections in 2018.

“Passage of this package, even a slimmed-down version, is going to be politically difficult,” Luzzetti said. “But we continue to see scope for a modest tax cut that is significantly less detrimental to the budget outlook than the plan presented this week, centered primarily on the corporate side and complemented by smaller personal tax cuts.”

Should a cut again approval, that would cast the spotlight on the Fed, the U.S. central bank that sets short-term rates which then influence levies on other forms of debt.

The Fed currently expects to approve one more increase this year, then six more through the end of 2019.

Should the tax cuts be approved and generate growth, Deutsche Bank’s analysis sees the Fed undertaking at least one or two more hikes than planned through 2019.

In addition to raising rates, the Fed is removing policy accommodation by shrinking its $4.5 trillion balance sheet, comprised mostly of bonds it accrued in stimulus programs from 2008-2014.

Later this month, the Fed will begin allowing a capped level of proceeds from its bonds to roll off the balance sheet. The caps will increase by $10 billion each quarter to reach a total of $50 billion, paving the way for the balance sheet likely to fall below $3 trillion over the next several years.

WATCH: Republicans face substantial political hurdles in passing reform.