Trump: The Economics
Don't panic. That is the first message for investors. After all that has been said in recent months, it would not be a surprise if some investors were concerned following Donald Trump's election as President. However, an equally important message might be to take a positive view of what might lie ahead for US economic policy.
The immediate financial market reaction was partly knee-jerk, as US assets sold off but this reaction was probably far shorter than many may have feared, in part this is because there has been a relatively quick and sober assessment of the President Elect's likely economic policies. Naturally, markets could be volatile as there is still much uncertainty about what lies ahead.
President Elect Trump appears to be viewed with suspicion by much of the world's media and is regarded as unpredictable and a loose cannon by many investors. Yet his acceptance speech was inclusive and he comes across as more of a manager, with a desire to get things done, than a slick politician.
Interestingly, the sell off in US bonds would indicate that the focus is on the reflationary aspects of Trump's aim to boost growth. His commitment to relax fiscal policy and deliver on growth should be positive for US equities. But with inflation already past its low, part of the market's focus will be a fear that inflation will creep higher. That could take its toll on US bonds.
Wages have recently crept higher. Although any shift in policy takes time, if this is seen also as the start of a trend towards a looser fiscal policy with a tighter monetary policy, then this too may be seen as dollar positive. Of course for markets, it is not just what he says but also the need to deliver it. It will take time to truly assess his policies.
Since the financial crisis, US markets have been driven by a combination of a liquidity cycle and an earnings cycle, with cheap money at the core. Corporate earnings have been good. Inflation has been low. Central bank policy had been largely predictable, avoiding policy shocks. Financial markets have performed well. Now, however, we may be moving from a liquidity and earnings cycle to a more traditional political and economic cycle. The election was an important aspect of this. If so it could trigger a shift in market thinking.
It was not just Donald Trump's victory that is remarkable, it is the impressive way in which the Republicans now hold power across the board. Their majority in the House of Representatives is solid and they have a working majority still in The Senate. Moreover, it is already being said that the seats being contested in two years’ time will allow the Republicans to retain control of The Senate at that stage. As a result, Trump may have solid Republican support for the whole of the next four years. The Republicans also had a strong showing in State Governorships. Trump's victory will allow him to make potentially far reaching appointments to the Supreme Court, where one seat is currently vacant.
The Republican Party's strong position will help ease the President's legislative agenda and ability to drive policy. He has promised change and now he must deliver it. For Americans, the focus will be on him delivering stronger growth and while that matters for the rest of the world too, there will be uncertainty over the future US approach to trade and NATO. In terms of trade, some in the markets fear Trump may be too protectionist - hence there have seen some references made to the economically damaging Smoot-Hawley Tariff of the 1930s. I think that is too pessimistic, but we need to watch how trade policy develops. More likely, the historical analogies that come to mind are in terms of fiscal policy: the 1930's New Deal of Roosevelt, given Trump's desire to boost the nation's infrastructure; and the 1980's tax cuts of Ronald Reagan, aimed at boosting the supply-side of the economy.
The combination of these would be growth positive. However, it would also reinforce concerns about the budget deficit, and this aspect is likely to be scrutinised closely by Congress and the markets.
A Trump victory can be seen as an endorsement not only of his criticism of the US political system but also as a reflection of the need to boost the domestic economy. So Congress may prove less of an obstacle than the markets.
At face value, Trump has promised to create 25 million jobs over the next decade, through a combination of reform in tax, trade, energy and regulatory policies. He has also committed to tax cuts; this attracted attention in the campaign, with a focus on his tax cuts for higher earners, but he has emphasised tax cuts also for the middle class and those on low earnings.
Trump has promised big tax cuts for business. This includes lowering the business tax rate from 35% to 15%. Other tax policies include eliminating the carried interest loophole for Wall Street and the real estate market. Trump has also said he will eliminate intrusive 'job-killing regulation'. So, at face value, he is for lower taxes and less regulation.
If he adopts a low tax, low regulation agenda, alongside some slippage in fiscal spending, then the domestic economy should benefit. Less clear is what happens to investment, but tax changes to ensure US firms return more of their offshore funds to invest at home should help. Confidence, too, is key, and if the President is seen as adopting a credible pro-growth agenda, where domestic demand holds up, then this might tempt firms to invest. But we should not be premature in assuming this. It is still very early days.
In terms of the budget deficit his aim is to reduce it. That, though, is what they all say. He wants to reduce non-defence, non-safety net spending by one per cent of the previous year's total each year. The US faces a big structural budget deficit problem and there is no easy way to address this. And yet, relaxing fiscal policy will boost the deficit, initially at least. So despite the Republican Party's general desire to reduce the budget deficit, the immediate focus in the US is more likely to be to relax fiscal policy in order to help rebuild the infrastructure - a key part of the President Elect's victory speech.
What about elsewhere? Outside of the US, the general trend has also been towards using fiscal policy more to boost domestic demand. The latter reflects not only the limits of monetary policy in many western economies, but also the message thrown up by the Brexit vote and now by the US elections: an underlying desire for more people to share in economic success.
Global investors will be focused also on the impact on trade and geopolitics. Trade deals and negotiations have become a far more political issue. Trump may decide to kill the TPP deal, and has said he will revisit NAFTA. The trade deal with Europe is less clear. This will create uncertainty at a time when global trade growth is already sluggish. In contrast, the future trade relationship with the UK may be positive.
In geopolitical and economic terms it is the Indo-Pacific region that is key for the US. The major geo-political risk there over the next year is likely to be North Korea, which is becoming a more serious risk than before. In economic, as well as geopolitical terms, the key is the US-China relationship. It is usual in a US election year for the rhetoric towards China to be tough - for instance Trump's comments on the Chinese currency and tensions in the south and east China Seas - only to change to a more business-like focus after the Presidential election. That is most likely to be the case now. For Europe, the key issue is that in time he may cut the US contribution to NATO. This may create near-term uncertainty in Western Europe, and in time may trigger a boost to defence spending.
What will be the impact on the Fed? A December rate hike still seems likely. The question then is what message the Fed will want to send about possible tightening over the coming year. Given their growth projections I would expect the Fed to signal at least a couple of 0.25% hikes in the year ahead. They will not be pre-emptive, as their behaviour over the last year has shown. Instead they will be heavily influenced by the data. And if the new President does relax fiscal policy, and in turn boosts growth, then this will lead the market to anticipate perhaps as many as four hikes in the year ahead. And this combination of looser fiscal, tighter monetary policy would likely be positive for US equites, prompt a steeper yield curve, and be dollar positive.
Finally, Donald Trump has to appoint his top team. The relationship with his Vice President, his Cabinet, as well as Congress and the Senate will set the tone for how people see his working environment. The first January State of The Union is often a key policy event for the new President, but way before then, there will be a desire for clarity about the key aims of policy.
The immediate financial market reaction was partly knee-jerk, as US assets sold off but this reaction was probably far shorter than many may have feared, in part this is because there has been a relatively quick and sober assessment of the President Elect's likely economic policies. Naturally, markets could be volatile as there is still much uncertainty about what lies ahead.
President Elect Trump appears to be viewed with suspicion by much of the world's media and is regarded as unpredictable and a loose cannon by many investors. Yet his acceptance speech was inclusive and he comes across as more of a manager, with a desire to get things done, than a slick politician.
Interestingly, the sell off in US bonds would indicate that the focus is on the reflationary aspects of Trump's aim to boost growth. His commitment to relax fiscal policy and deliver on growth should be positive for US equities. But with inflation already past its low, part of the market's focus will be a fear that inflation will creep higher. That could take its toll on US bonds.
Wages have recently crept higher. Although any shift in policy takes time, if this is seen also as the start of a trend towards a looser fiscal policy with a tighter monetary policy, then this too may be seen as dollar positive. Of course for markets, it is not just what he says but also the need to deliver it. It will take time to truly assess his policies.
Since the financial crisis, US markets have been driven by a combination of a liquidity cycle and an earnings cycle, with cheap money at the core. Corporate earnings have been good. Inflation has been low. Central bank policy had been largely predictable, avoiding policy shocks. Financial markets have performed well. Now, however, we may be moving from a liquidity and earnings cycle to a more traditional political and economic cycle. The election was an important aspect of this. If so it could trigger a shift in market thinking.
It was not just Donald Trump's victory that is remarkable, it is the impressive way in which the Republicans now hold power across the board. Their majority in the House of Representatives is solid and they have a working majority still in The Senate. Moreover, it is already being said that the seats being contested in two years’ time will allow the Republicans to retain control of The Senate at that stage. As a result, Trump may have solid Republican support for the whole of the next four years. The Republicans also had a strong showing in State Governorships. Trump's victory will allow him to make potentially far reaching appointments to the Supreme Court, where one seat is currently vacant.
The Republican Party's strong position will help ease the President's legislative agenda and ability to drive policy. He has promised change and now he must deliver it. For Americans, the focus will be on him delivering stronger growth and while that matters for the rest of the world too, there will be uncertainty over the future US approach to trade and NATO. In terms of trade, some in the markets fear Trump may be too protectionist - hence there have seen some references made to the economically damaging Smoot-Hawley Tariff of the 1930s. I think that is too pessimistic, but we need to watch how trade policy develops. More likely, the historical analogies that come to mind are in terms of fiscal policy: the 1930's New Deal of Roosevelt, given Trump's desire to boost the nation's infrastructure; and the 1980's tax cuts of Ronald Reagan, aimed at boosting the supply-side of the economy.
The combination of these would be growth positive. However, it would also reinforce concerns about the budget deficit, and this aspect is likely to be scrutinised closely by Congress and the markets.
A Trump victory can be seen as an endorsement not only of his criticism of the US political system but also as a reflection of the need to boost the domestic economy. So Congress may prove less of an obstacle than the markets.
At face value, Trump has promised to create 25 million jobs over the next decade, through a combination of reform in tax, trade, energy and regulatory policies. He has also committed to tax cuts; this attracted attention in the campaign, with a focus on his tax cuts for higher earners, but he has emphasised tax cuts also for the middle class and those on low earnings.
Trump has promised big tax cuts for business. This includes lowering the business tax rate from 35% to 15%. Other tax policies include eliminating the carried interest loophole for Wall Street and the real estate market. Trump has also said he will eliminate intrusive 'job-killing regulation'. So, at face value, he is for lower taxes and less regulation.
If he adopts a low tax, low regulation agenda, alongside some slippage in fiscal spending, then the domestic economy should benefit. Less clear is what happens to investment, but tax changes to ensure US firms return more of their offshore funds to invest at home should help. Confidence, too, is key, and if the President is seen as adopting a credible pro-growth agenda, where domestic demand holds up, then this might tempt firms to invest. But we should not be premature in assuming this. It is still very early days.
In terms of the budget deficit his aim is to reduce it. That, though, is what they all say. He wants to reduce non-defence, non-safety net spending by one per cent of the previous year's total each year. The US faces a big structural budget deficit problem and there is no easy way to address this. And yet, relaxing fiscal policy will boost the deficit, initially at least. So despite the Republican Party's general desire to reduce the budget deficit, the immediate focus in the US is more likely to be to relax fiscal policy in order to help rebuild the infrastructure - a key part of the President Elect's victory speech.
What about elsewhere? Outside of the US, the general trend has also been towards using fiscal policy more to boost domestic demand. The latter reflects not only the limits of monetary policy in many western economies, but also the message thrown up by the Brexit vote and now by the US elections: an underlying desire for more people to share in economic success.
Global investors will be focused also on the impact on trade and geopolitics. Trade deals and negotiations have become a far more political issue. Trump may decide to kill the TPP deal, and has said he will revisit NAFTA. The trade deal with Europe is less clear. This will create uncertainty at a time when global trade growth is already sluggish. In contrast, the future trade relationship with the UK may be positive.
In geopolitical and economic terms it is the Indo-Pacific region that is key for the US. The major geo-political risk there over the next year is likely to be North Korea, which is becoming a more serious risk than before. In economic, as well as geopolitical terms, the key is the US-China relationship. It is usual in a US election year for the rhetoric towards China to be tough - for instance Trump's comments on the Chinese currency and tensions in the south and east China Seas - only to change to a more business-like focus after the Presidential election. That is most likely to be the case now. For Europe, the key issue is that in time he may cut the US contribution to NATO. This may create near-term uncertainty in Western Europe, and in time may trigger a boost to defence spending.
What will be the impact on the Fed? A December rate hike still seems likely. The question then is what message the Fed will want to send about possible tightening over the coming year. Given their growth projections I would expect the Fed to signal at least a couple of 0.25% hikes in the year ahead. They will not be pre-emptive, as their behaviour over the last year has shown. Instead they will be heavily influenced by the data. And if the new President does relax fiscal policy, and in turn boosts growth, then this will lead the market to anticipate perhaps as many as four hikes in the year ahead. And this combination of looser fiscal, tighter monetary policy would likely be positive for US equites, prompt a steeper yield curve, and be dollar positive.
Finally, Donald Trump has to appoint his top team. The relationship with his Vice President, his Cabinet, as well as Congress and the Senate will set the tone for how people see his working environment. The first January State of The Union is often a key policy event for the new President, but way before then, there will be a desire for clarity about the key aims of policy.
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