Macro View: World adjusting to president-elect Trump

DONALD TRUMP’S shock victory in the US Presidential elections has triggered greater instability in the financial markets. But the overall effects of Trump’s victory have, on balance, been positive – and the optimistic tone is likely to continue in the short term.

After large but short-lived net falls as soon as the results became known, share prices recovered quickly and the net upward trend has been maintained. Stock markets in the US, Japan and in most of Europe are now higher than before the US elections.

One can expect uncertainties and volatility to persist in the near future. It will take time until the detailed economic policies of the new administration become clear. But we know that Trump wants to adopt measures aimed at raising the growth rate of the US economy, and that he is very pro-business. Trump supports lowering taxes and sweeping away the regulatory burden that is hampering US businesses.

At the same time, the president-elect has expressed protectionist views, and said that the US will quit the Trans-Pacific Partnership trade deal on his first day in the White House. He also wants to renegotiate the North America Free Trade Area (NAFTA), which now governs trade relations with Canada and Mexico.

Protectionism a concern

If the new president unleashes a surge in global protectionism, negative consequences would follow. But it is premature to expect this to happen. For the time being, Trump’s commitment to higher growth is more important for the markets than any adverse effects resulting from fears over protectionism.

As part of his pro-growth approach, Trump wants to increase significantly infrastructure spending, and this will push up share prices of many companies. But big infrastructure programmes will also mean higher deficits, higher debt and, eventually, higher inflation.

The new Republican Congress is fiscally conservative and, while wishing to support the new president, will oppose huge spending increases. While Trump will be able to raise spending and budget deficits, the increases will be more moderate than he may wish. This fiscal expansion will add to US economic growth in the next 2-3 years. There is a danger that that inflationary pressures will also swell. However, as long as the fiscal expansion is not excessive, the upturn in US inflation will be gradual and not get out of control.

Markets and policy

The financial markets are now adjusting to the policy changes likely to be implemented after Trump takes over in January 2017. Equities will do relatively well if Trump is able to implement his policies.

Share prices will continue to go up overall, provided that increases in inflation remain moderate. But equities will be more volatile than in the recent past, and they could be highly vulnerable if the upturn in inflation gets out of hand.

In contrast to equities, the bond markets would inevitably be damaged, and we have already seen dramatic changes in recent weeks. Yields on fixed-rate government bonds have risen markedly since Trump’s victory, and bond prices have fallen quite sharply. These trends will continue, and probably intensify the next 12-18 months. The markets are now pointing to larger increases in US interest rates in the foreseeable future than previously predicted. The same trends – higher bond yields and higher inflation – will also be apparent in the UK, which is moving to a more expansionary policy stance following the Brexit referendum.

Eurozone and Japan

The position is different in the eurozone and in Japan, because their central banks have been committed until recently to a further loosening of monetary policy, in order to push their inflation rates towards their respective targets.

This divergence, between the US & the UK on the one hand and the Eurozone & Japan on the other, has been reflected in the currency markets. Since Trump’s victory, the yen and the euro have fallen against the US dollar and sterling, even though the British pound still shows large net falls compared with its pre-referendum value. But there are signs of change.

The ECB has decided not to inject any further stimulus at its November meeting and there are signs that Mario Draghi will prefer to avoid, or at least postpone for the time being, additional expansionary measures. Political opposition to lower interest rates is mounting in Germany. In 2017, the Netherlands, France and Germany will vote in national elections that could be affected by the Trump and Brexit victories.

Given this sensitive background, the ECB may be wise to be more cautious, even though it will not contemplate raising rates. In Japan, there are also signs that the massive monetary stimulus will gradually end, because it is clearly ineffective; there will be no monetary tightening, but if further stimulus is deemed necessary, the government will have to rely more on fiscal policy

US prospects ‘mediocre’

US economic prospects remain mediocre by historical standards, but they are still better than in Japan and Europe, and they are being upgraded slightly.

Its growth, after a temporary relapse to 1.5% in 2016, is forecast to accelerate gradually, to 2.2% in 2017 and 2.4% in 2018. US GDP increased at an annualised rate of 2.9% in the third quarter of 2016, after rising at a rate of 1.4% pace in the second quarter. The acceleration in growth, which exceeded expectations, was due to higher exports, increased inventories and higher business investment; this was partly offset by a slowdown in consumer spending.

The US economy created 161,000 jobs in October 2016, slightly below expectations, but the figures for August and September were revised up. In the first ten months of 2016, US job creation averaged 181,000 per month, well below the 229,000 average in 2015 as a whole. But the US labour market remains solid overall. The unemployment rate is low, at only 4.9%.

With annual growth in wages accelerating to 2.8%, and with US inflation edging up, the case for early monetary tightening is strengthening. A December rise in US Fed rates was widely expected even before Trump’s victory; but expectations that the upward trend in interest rates will continue and intensify in 2017, are likely to strengthen.

UK ‘expansionary fiscal stance’

The UK’s Autumn Statement highlighted the country’s move towards a more expansionary fiscal stance. Philip Hammond, the new chancellor, confirmed that George Osborne’s plans to return to budgetary surplus before the end of the decade are being abandoned.

The squeeze on current spending will be maintained, and the deficit will still be gradually reduced. But the timetable will be extended over a longer period and Hammond has announced a sizable infrastructure programme aimed at boosting Britain’s productivity. UK growth forecasts are being upgraded further, to 2.1% in 2016 and 1.4% in 2017, confirming that the post-Brexit pessimism about growth prospects has been unjustified.

Annual consumer price inflation edged marginally down, to 0.9% in October from 1.0% in September. But in reaction to recent sharp falls in sterling it seems highly likely that inflation will increase above the official 2% target in 2017 and 2018. Given this background, the Bank of England is unlikely to ease policy any further, and may even raise rates slightly from mid-2017 onwards, particularly if US Fed rates continue to increase next year.

 

David Kern of Kern Consulting was chief economist at the British Chambers of Commerce between 2002 and 2016. He was group chief economist at NatWest between 1983 and 2000

 

Table 1: GDP Growth – Major Economies

% Change on Previous Year

2014 2015 2016 2017 2018
The US 2.4% 2.6% 1.5% 2.2% 2.4%
Japan -0.1% 0.5% 0.6% 0.9% 1.0%
Eurozone 0.8% 2.0% 1.5% 1.3% 1.5%
Germany 1.6% 1.5% 1.7% 1.3% 1.6%
France 0.2% 1.3% 1.3% 1.2% 1.4%
The UK 2.9% 2.2% 2.1% 1.4% 1.9%
China 7.4% 6.9% 6.7% 6.4% 6.2%
India 7.3% 7.6% 7.6% 7.5% 7.3%
Brazil 0.1% -3.8% -3.2% 1.1% 1.3%
Russia 0.6% -3.7% -0.7% 1.3% 1.5%
World-PPP 3.4% 3.2% 2.9% 3.2% 3.4%

Sources: Actual figures from official sources

Forecasts from David Kern, Kern Consulting

 

Table 2: Official Interest Rates

Forecasts for Next 2 Years
Actual Forecasts – end-quarter
  25.11.16 31.12.16 31.03.17 30.06.17 31.12.17 31.12.18
US Fed Funds Rate 0.25-0.50% 0.50-0.75% 0.75-1.00% 0.75-1.00% 1.25-1.50% 2.00-2.25%
ECB Refi Rate 0.00% 0.00% 0.00% 0.00% 0.50% 1.00%
Japan Overnight Rate -0.10% -0.20% -0.20% -0.10% 0.00% 0.50%
China base interest Rate 4.35% 4.10% 4.10% 4.10% 4.35% 4.60%
UK Bank Rate 0.25% 0.25% 0.25% 0.50% 1.00% 2.00%

Sources: Actual figures from official sources

Forecasts from David Kern, Kern Consulting

 

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