Saker Nusseibeh, Chief Executive
Donald Trump has defied the odds and ridden a wave of popular support to defeat Hillary Clinton to become the next US President. Given the consensus view that Trump and Clinton’s policy pitches were similarly themed – both have a protectionist orientation, both aimed for fiscal stimulus, Trump through lower taxes and Clinton through increased government spending, and both pledged to increase defence spending – and that a US President’s effective executive power is limited by design, markets should shrug off the results of this election after a bout of initial volatility as they have done in the past. Our fear, however, is that consensus might underestimate the fact that Trump could damage the economy in the long term, despite the limited powers of a US President through his political stances.
Since the introduction of fiat currencies, governments rely on their reputation as a measure of trustworthiness in order to reduce their risk premium in capital markets. Given Trump’s unusual campaign, it is not a stretch to imagine him repeating his campaign talk of renegotiating US debt. Although everyone knows such an outcome is highly improbable, a President mentioning the idea might lead to serious volatility in US Treasury markets and increase risk premia for US assets.
Trump might create market volatility through his pronouncements in the field of foreign policy, traditionally a preserve for presidential authority. The assumption is that Trump will listen to advice from professionals in the US State Department when dealing with foreign affairs, but on the campaign trail he demonstrated a clear willingness to dismiss professional advice, to the delight of his support base. Once again it is not a stretch to imagine Trump in talking to his home constituency might alienate the traditionally supportive Gulf nations with his Islamophobic comments. This might then strengthen Iran’s influence in the region, which could threaten regional stability and therefore the oil price. Likewise, Trump’s anti-NATO and pro-Vladimir Putin comments could be taken, if repeated when he is in power, as a green light by the Russian President to intensify his revanchist foreign policy in Eastern Europe. This in turn could lead to rising risk premia for European assets.
Neil Williams, Group Chief Economist
Markets will be on the back foot after Trump’s win, given the potential for a paradigm shift that disrupts financial assets, macro-economics, and trade policy. With some of his trade and immigration proposals looking extreme, though, he will doubtless have to water them down to get past a Congress that was losing faith in his candidacy.
Renewed volatility will now blur the path for US interest rates – but it still doesn’t point to an aggressive Fed. The short-term stimulus from Trump’s sizeable fiscal expansion should be muted by his threat of widespread protectionism, and the possibility of a hit to US asset prices. This would be exacerbated if he repeats his threats to reschedule US government debt or interfere in the Fed’s decision-making, or do both. The former, though, seems unlikely, given Congressional objection, and the fact the debt is denominated in US dollars.
His macro plans are likely to lead to slower growth, and a weaker footing for an economy that may have to weather some subsequent distress to asset prices (higher money rates, weaker equities). He advocates tax cuts skewed toward higher earners, yet reductions to immigration and trade. Taken literally, this infers a hit to tax revenue of about $4tn (22% of GDP) over five years, which would only be part financed by spending cuts. Congress could push back on this.
It could oppose his aggressive 45% and 35% tariffs on China and Mexico and review of NAFTA. But, the risk is he enacts ‘Super 301’ (section 301 of the 1974 Trade Act) to impose tariffs without Congressional approval on countries engaged in “unfair” trade practices.
In which case, expect a broadening to include other countries whose ‘cheaper’ imports then fill the gap, subsequent global retaliation, and a flow-back from Mexico (which relies on the US for 80% of its exports and the bulk of remittances), Canada, and a likely China currency devaluation.
Inflation, but the wrong sort...
Trump’s anti-immigration threats would surely only accelerate the US’s shrinking labour supply, which is still close to a 36-year low, and cut potential growth. This may spur wage growth, but the inflation that protectionism spawns will likely be the ‘wrong sort’ – cost push, rather than demand-pull. In which case, the Fed will have to turn a blind eye.
So, while the Fed remains the test case for whether any central bank can ‘normalise’ interest rates after immense quantitative easing, we expect it to fail – peaking out at a maximum funds target rate in this cycle of just 1%. This is much lower than its historic average of about 5%, and makes the FOMC’s continued preference for a 3% peak after 2018 look increasingly unrealistic.
Macro implications of Trump presidency
|GDP growth||Negative long-term. Short term, advocates tax cuts, but trade & immigration curbs, & financial markets' reaction risk recession.|
|Fiscal stance||Expansionary, & more front-end loaded. Lower tax rates for all skewed to the higher-income end, partly offset by spending cuts. Congress, though, would try to limit big revenue hit.|
|Monetary policy||Negative if he attempts to appoint a like-minded Fed chairman & depose Yellen.|
|Equities/growth assets||Negative, given recession threat & perception of global retaliation with beggar-thy-neighbour policies.|
|Inflation/TIPS||Positive. Near term, given threatened fiscal splurge & likely hit to the USD. Longer-term, even in recession, closed-economy policies could trigger cost-push stagflation.|
|Conventional Treasuries||Supportive short-term, given threat of unraised debt ceiling & recession risk. Further out, bear curve steepening on fiscal splurge & feared Fed interference.|
Source: Hermes Investment Management, Ahead of the Curve, November 2016
Geir Lode, Head of Global Equities
Markets dislike uncertainty, and confirmation of Donald Trump’s victory has heightened the potential for wildcard US policies on many fronts. We expect volatility to return as investors gauge how many of the President’s campaign promises can actually be fulfilled: it is likely that many will not be supported by Congress without moderation, but markets are likely to be anxious until this is confirmed.
- Tanks, toll roads and tariffs: We expect Trump to take bold, decisive actions in an attempt to fix the US economy, even if Congress manages to lessen the severity of his policies. Defence and infrastructure spending will significantly increase, given his campaign promises. Tax rates will fall, and tariffs will be put in place to support US companies.
- Penalties of protectionism: Any benefits from these policies are likely to be short-lived, and in the long term we expect global trade to become constrained as the US becomes more protectionist. President Trump may win popular support by limiting immigration but the damage this causes the US economy will be monumental, with an estimated 11m fall in the US labour force and potential $1.6tn contraction in GDP.
Trump’s denial of human-made climate change is also concerning. COP21 in Paris last year marked a change in the fight against global warming as governments across the world boldly pledged to slow carbon emissions in their respective economies. A reversal of the US’s commitment to reduce emissions could lead to other governments reneging on their promises.
Mark Sherlock, Lead Portfolio Manager, US Small and Mid Cap
What seemed like an outlier result only 12 months ago has become true: Donald Trump has been elected US President. The reasons for this momentous event will be analysed for years to come, but in the immediate aftermath it appears that a widespread feeling of disenfranchisement among Americans and distrust of the establishment surely played an important role. Trump offered a protectionist, ‘America-first’ vision of the future that appealed to voters and he now needs to deliver this.
For markets, it is likely that his Presidency will begin with a period of increased volatility as investors separate real policies from pre-election rhetoric. Further, geopolitical risk has risen given Trump’s political inexperience, unpredictability and caustic manner. His proposed cuts to personal and corporate tax rates will help the economy in the short term, but the spectre of his increasingly protectionist policy agenda may undermine US economy in the long term.
However, his victory is not all bad news: Trump is unabashedly pro-business, and the American political system has numerous checks and balances which should prevent him from enacting any of his ill-considered policy initiatives. The US has long been a great place to do business and it seems unlikely that any one individual – even the President – will materially change this.
Forget the election and watch the Fed