Donald Trump’s economic policies focus on three key areas; protectionism, loose fiscal policy and deregulation. In this summary report, we will give an overview of Trump’s policies before exploring the effects that they have had on financial markets. For conciseness, we will not look at Trump’s immigration policies and plans to ‘clean up Washington’.
Protectionism
Trump is no proponent of free trade. Branding NAFTA as the “worst trade deal ever”, vowing to withdraw from the Trans-Pacific Partnership (TPP) in his first day in office and promising to apply heavy tariffs to US companies who outsource, Trump’s election could spell uncertain times for the US and its key trade partners.
One of Trump’s main campaign pledges was to renegotiate or withdraw from the North American Free Trade Agreement (NAFTA), blaming it for destroying the US manufacturing sector. It is true that since the adoption of NAFTA in 1994, the US goods trade balance with Mexico has swung from a $1.6bn surplus to a $60.7bn deficit. Over the same period, the goods trade deficit with Canada increased from $10.8bn to $15.5bn. However, this is not necessarily a direct result of the trade agreement. Between 1993 and 2015, the US global (excl. Canada and Mexico) trade deficit in goods exploded by 529% from $106.5bn to $669.5bn, marking a clear trend in corporate outsourcing. While one cannot doubt that the US manufacturing sector was hurt by this trend, many argue that it cannot be attributed to NAFTA. A renegotiation of the deal requires the approval of congress but no approval is required to withdraw from the deal, provided Canada and Mexico are given 6 months’ notice.
In his 100-day plan and in a consequent video following the election, Trump vowed to withdraw from the Trans-Pacific Partnership during his first day in office. Due to his post-election persistence in the matter and lack of congress approval required, the move is highly expected.
Japanese Prime Minister, Shinzo Abe, said that the deal would be “meaningless without the US”. Analysts believe that the abandonment of the partnership, which excludes China, will boost China’s competitive advantage within the APAC region and fuel discussions on the China-led Regional Comprehensive Economic Partnership. Trump is also very critical of TTIP (Transatlantic Trade and Investment Partnership) and is widely expected to discontinue its negotiation.
Trump’s ‘End the Offshoring Act’ proposes to establish tariffs to prevent US companies from outsourcing their manufacturing to other countries, although no additional details were given. The president elect talked during the election about a 45% tariff on Chinese goods and a 35% tariff on Mexican goods. Whilst most agree that this extreme tariffs will not be applied, Trump is likely to increase tariffs with America’s key trading partners.
Loose Fiscal Policy
Highly irregular during a bull market, Trump’s second key policy area is that of cutting taxes and increasing government expenditure. This comes in the form of the American Energy and Infrastructure Act, the Restoring National Security Act, the Restoring Community Safety Act and the Middle Class Tax Relief and Simplification Act.
The ‘American Energy and Infrastructure Act’ consists of $1 trillion of investments in infrastructure in order to boost the economy and ‘put millions of people to work’.
In what he dubbed the ‘Restoring National Security Act’, Trump promised to eliminate the defence sequester and expand military investment. In the ‘Restoring Community Safety Act’ he similarly promised to increase funding for federal law enforcement agencies and programs that train and assist local police.
During the election, Trump proposed an overhaul of the income and corporate tax system in what he called the ‘Middle Class Tax Relief and Simplification Act’. The new system would see inheritance and estate tax abolished, reduce the corporate tax rate from 35% to 15%, reduce income taxes (a middle class family with 2 children would get a 35% tax cut) and allow income tax deductions for childcare and eldercare. Critics of this plan claim it would disproportionately benefit the wealthy.
Deregulation
Trump has also promised to vastly reduce regulation in the US, which he states is “killing jobs”. In his 100-day plan, he stated his aim to submit a requirement that two regulations must be removed for every new federal regulation. Although he speaks very broadly on deregulation, giving few specifics, he has signalled his intentions with regards to two key areas; financial services and energy production.
After vowing to repeal the Dodd-Frank Act during his campaign, Trump has since nominated Paul Atkins, an ex SEC commissioner, as part of his transition team. Atkins is a staunch critic of heavy financial regulation and large fines for offending companies, and an assailant of Dodd-Frank. Other than his comments on Dodd-Frank, Trump himself has said very little about financial deregulation but his sentiment is clear. While a full dismantling of Dodd-Frank does not seem likely, analysts are expecting its reform under the Trump administration as well as a lighter regulatory burden on banks.
Trump once stated that global warming was “created by the Chinese in order to make US manufacturing non-competitive.” His policies reflect this sentiment, vowing to “lift the restrictions on the production of $50 trillion dollars’ worth of American energy reserves, including shale, oil, natural gas and clean coal” and to cancel payments to UN climate change programs.
Impact on Markets
The most significant impact on the markets was the rise in US government bond yields. Shortly before the election the 10Y US government yield was at about 1.7 percent and since then it has climbed to over 2.4 percent for the first time since the summer of 2015. The two-year note yield, the one most acutely sensitive to interest rate expectations, climbed to a six-year high of 1.15 percent. This shift was mainly due to the fact that the market priced in a higher probability of the ‘American Energy and Infrastructure Act’ since the Republican sweep of the White House and Congress, coupled with president-elect Trump’s promise to unleash a $1tn economic stimulus package of tax cuts and infrastructure investments.
Moreover, the moves came after the US Department of Commerce said that orders for durable goods had risen by 4.8 per cent in October, smashing economists’ expectations and reinforcing the sense that any stimulus package will come at a time when the economy is already in reasonable shape, and will therefore fuel inflation. This view is also supported by a survey by Bank of America Merrill Lynch, which showed that inflation expectations among portfolio managers had reached their highest level in more than a decade.
A sharp rise in global bond yields since Mr. Trump’s triumph has also spurred an underperformance of European credit, relative to the US corporate debt market. Higher corporate credit spreads in euros, measuring the risk of company debt compared to a benchmark rate, come despite ongoing purchases by the ECB which began buying bonds in June and initially drove down borrowing costs for the continent’s companies. The spread on the Bloomberg Barclays Euro Aggregate Corporate Index has risen to 77 basis points this week, compared to 65 basis points immediately before the election. Over the same period, spreads on investment grade corporate bonds in the US have edged lower.
Corporate Bond Spreads (Source: Bloomberg)
The president-elect’s polices include a large cut in US corporate tax rates and also incentives for companies to repatriate profits generated overseas. Moreover, smaller companies outperformed due to expectations of protectionist measures which are more likely to hurt larger multinational companies. Additionally, a stronger US dollar has accelerated momentum in favour of smaller companies, which tend to be more domestically focused and rely less on foreign-based revenues, unlike larger multinationals that dominate the S&P 500. First signs of this trend are that the Russell 2000 index of small-caps has risen 12.3 percent since the election while the S&P 500 is only up 3.1 percent.
US equity fund inflows ($bn) (Source: Bloomberg)
Another major trend since the election is that stocks in the financial and pharmaceutical sector outperform and tech stocks underperform. One reason is clearly the outlook of looser regulation as outlined above. However, another factor is that financial stocks profit from a steeper yield curve. This is due to the fact that banks lend money in the long term for a higher yield and refinance them through short term instruments with a lower yield. Therefore, a steeper yield curve, which is equivalent to a higher spread between long term yields and short term yields, result in a higher margin for banks.
The impact on the commodities market was mixed as oil and gold prices slightly decreased, whereas copper traded significantly higher due to the planned infrastructure projects. Rolling back the Clean Power Plan would make coal more competitive with natural gas, however, which could negatively impact the oil and gas industry. Eliminating regulations that force the shut down or conversion of coal-fired power plants to natural gas could hurt natural gas demand and natural gas prices.
Conclusion
The election will most likely mark a turning point for the more than 30-year bull market in US government bonds. One main factor of the bull market was globalization which caused higher competition and a pressure on prices, which at the same time provided the Federal Reserve the possibility to lower interest rates without causing inflation. However, taking into account the plans of Trump and assuming that he will be able to partially implement them, one has to expect a more protectionist economic policy in the future. Additionally, a less loose interest rate policy of the Federal Reserve and fiscal loosening during a period of already stable economic growth and a solid job market is expected to be a major driver for higher yields in the future. However, due to the negative impact of a strong US dollar on emerging markets, this trend could be slowed down by weaker economic growth in those markets.
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