Almost two weeks after Donald Trump was elected to be the next president of the United States, financial markets are still confounding expectations about how they would react to a Trump presidency.
Initially stock markets fell sharply on the news, but they quickly recovered and are now at the highs of the past few years. The biggest move has been in the bond markets, with the yield on the 10-year Treasury bond leaping to 2.35 per cent, its highest of the year. The dollar has also made a substantial move higher, taking it back to the top of the trading range of the past 13 years.
This outperformance can be put down to a number of factors, which all come back to a perception of divergence; divergence in terms of economic growth, interest rates and politics. With less of the incendiary language and rhetoric that characterised the Trump campaign, the markets are warming to the outline of what Mr Trump’s economics policy looks likely to be, give or take a few exceptions.
The main aspects are for a fiscal stimulus based around a planned US$1 trillion increase in infrastructure spending over the next 10 years, and substantial income and corporate tax cuts. Other elements include less regulation benefiting the financial and energy sectors.
Less favourable, however, is the threat of protectionism, raising concerns that rising trade barriers will undermine global trade growth and ultimately hurt US growth as well.
The independent Committee for a Responsible Federal Budget (CRFB) has said that Mr Trump’s plans would entail government borrowing being raised by an extra $5.3tn in the coming decade, taking the national debt from 77 per cent of GDP to 105 per cent of GDP.
Mr Trump claimed his plan would work because “we will double our growth rate and have the strongest economy in the world”, with his team having previously talked of growth being raised from 2 per cent to 3.5 per cent. This would take the US growth rate back to where it was for much of the decade before the financial market crash in 2008, giving rise to sharp economic divergence between the US and the rest of the world.
There will be concerns that the Republican Congress could baulk at such an increase in debt, but for the time being markets appear to be buying into the likelihood that a large fiscal stimulus is on its way, and that US growth will soon surpass most of its rivals.
With the economy already near full employment, inflation expectations have been lifted, providing the Fed with even more reason to act to normalise interest rates, which will result in greater interest rate divergence as well.
Beyond economic growth and interest rates, the third divergence is in terms of politics and is perhaps the most important factor that lies behind the rally in markets. It is also the one that could still derail it. Donald Trump rode an enormous wave of populism that propelled him into the White House. Similar trends were observable in the Brexit referendum in the UK. But unlike that referendum, the US election stands the chance of delivering policies that could generate very much stronger growth in a relatively short space of time.
Such populism puts the US on a divergent path with many of its rivals, with the euro zone mostly still resisting pressure from electorates for change. While Mr Trump has a surplus of political capital to do things, many governments of Europe facing elections next year have deficits.
However, so far all that has been seen since the election is the positive side of such populism. Mr Trump has toned down the campaign’s invective and rowed back on some of his most controversial plans, which has in turn reduced market volatility.
However, it may not take much for the negative side to reappear. There is still the potential for an enormous amount of uncertainty about his fiscal plans and whether they will be passed by Congress. Furthermore, his more controversial policies related to anti-globalisation, trade and immigration have not gone away, and could undermine the expansion that his other policies are aimed at generating. Until the inauguration in January, these may not be at the forefront of investors’ minds – but don’t count on them not to return when Mr Trump finally takes office.
Tim Fox is the chief economist and head of research at Emirates NBD
business@thenational.ae
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