A sideways look at economics
He has insulted women, Mexicans, journalists, people with disabilities and many more, but Donald Trump continues to bulldoze his way ever closer to the White House. Is there any stopping him? And what does this mean for markets? For all of Trump’s progress, there has been very little reaction in financial markets so far. Do they really care?
Perhaps not. After all, Hillary Clinton all but wrapped up the Democratic nomination this week and is the favourite to win November’s US presidential election. So why bother about Trump, we hear you say? Well, although Clinton is the favourite, the odds of her becoming president are only about as good as the UK voting to remain in the EU! That’s why. Shock horror.
In all likelihood, markets will turn their attention to Trump once the UK referendum is out of the way. Indeed, they only really woke up to the prospect of Brexit around three months ahead of the vote, even though it had been on the cards for some time before that. No point in worrying about Trump any sooner seems to be the view….
So what would Trump mean for the economy and markets? Well, he has threatened to pay back US government debt at a discount, has said that a strong dollar sounds better than it actually is, and he is all over the place with his views on the Fed. These are very important issues, but it would be foolish to take much of what he says that seriously given the seemingly ad hoc way in which he comes up with (and changes) many of his policy ideas. That being said, Trump-related uncertainty will probably hurt business sentiment and investment.
To his credit, Trump has provided more clarity when it comes to trade and international relations, although this is unlikely to be viewed very favourably by markets. He seems determined to start trade wars with China and Mexico, by branding the former a currency manipulator and threatening to block remittances to the latter. Supply chains for a number of US businesses would be disrupted and new tariffs on imported goods would put upward pressure on inflation (as would his fiscal proposals).
That being said, the outlook for economic growth under Trump might not really be that bad after all. The wall building, infrastructure and defence sectors would all benefit for a start. And although Mexico would pay for that wall, Trump has pledged to spend $1 trillion on US infrastructure and defence. We would welcome greater emphasis on fiscal policy to the extent that it eases the burden on monetary policy. But Trump seems to have taken this to a new level by pledging $9.5 trillion in tax cuts in addition to his spending plans! Quite how he manages to do this, while reducing the budget deficit, remains a mystery. The Tax Policy Center reckon that the increase in government debt as a result of Trump’s plans would offset all of the incentive effect of the tax cuts. Nevertheless, this additional fiscal stimulus would presumably prompt the Fed to tighten rates faster than it otherwise would, which could help solve the US productivity problem!
Overall then, how does one disentangle the knowns, known unknowns and unknown unknowns of Donald Trump’s potential policies and their effect on the economy and markets? Risk premia on risky US assets would probably increase, which would be bad for equities. But more government spending and higher inflation would be good for many sectors. The risk premium on US Treasuries would probably rise (due to higher fiscal spending, inflation and default risk), putting downward pressure on their prices. However, a Trump presidency would also probably spook investors globally, which, ironically, would probably increase demand for Treasuries, as well as putting upward pressure on the dollar (hey, that happened during the subprime crisis!). Oh no wait, but Trump doesn’t want a stronger dollar. Aghhhh! Whatever happens, let’s hope that markets take a more favourable view than they have with Trump Holdings & Casino Resorts.