It has happened. The continued failure of global policy makers to address the compelling economic challenge of our age – the slow burning global growth and income crisis – has spurred the US electorate to embrace the anti-systemic. Much of the world will wait to see if president elect Trump pivots towards the centre in terms of his economic, social and trade policies. As we wait, we can consider what would happen if President Trump was not bluffing, if he enacts his full economic agenda. While this is unlikely, it provides a possible limiting extreme in terms of the potential economic and market impact of a trump Presidency.
Some implications leap out. A fiscal expansion that could dwarf the Bush tax cuts – a package amounting to a USD5.8trn expansion in Federal debt – would provide a sugar-rush leap to economic growth. The switch to fiscal reflation would enable the Fed to enact it’s desire to tighten policy, and could reverse the multi-year downtrend in the neutral Fed Funds rate. The consequence is highly negative for USTs. Meanwhile, President Trump’s stated desire to weaken the USD could be initially undermined by policies to encourage a repatriation of overseas liquidity and by a policy outlook for much looser fiscal and somewhat tighter monetary policy. Trump’s projectionist leanings could also spark crisis among key emerging markets, with China being particularly vulnerable, as Beijing may be pressured into implementing deflationary policies at a time when its highly levered economy was struggling with a structural slowdown. Into the initial period of “Trumponomics”, US risk assets could defy conventional wisdom and perform well into the expected flurry of activity in Trump’s first 100 days, especially in relation to overseas markets.
However, from a longer- timeframe, optimism in the immediate US economic and market response to untrammelled Trump policies could be fleeting and represent a pyrrhic achievement. Undiluted Trump policies would represent an accelerated withdrawal of the world economy from 40 years of globalisation and liberalisation, which has so supported economic and financial market growth. The significance of this regime shift could not be over-stated. Actual and potential global growth would continue to fall, as would the alarming decline in global productivity growth. This would be an economic story that may not end well. Hence, hope for the policy pivot and if not, enjoy the sugar-rush phase of growth which may not last
The slow burning global growth crisis tears down another shibboleth
The slow-burning global growth and income crisis has been a leitmotif of our analysis. It has spurred our frustration at the inadequacy of a global policy response that remains un-coordinated both geographically and across reflationary levers. (The global growth crisis – a better coordination of reflationary levers?.) It also fuelled our concerns that if unaddressed, the backdrop of weak economic and income growth could fuel an embrace of anti-systemic political choices and policy platforms. Despite our focus on these issues, we nonetheless still under-estimated the pace at which demand for a political and policy regime shift would gather. First was the shock of the UK voting to leave the EU. Now, there is reality of a Trump Presidency. Against this background beat of weak economic and income growth, nervousness must envelope all mainstream parties and governments who face populist opposition who proffer policies rooted in ideas of economic, social and political exceptionalism. The risks associated with the wave of European elections in 2017 have inevitably been elevated by Trump’s victory.
What if trump was not bluffing? What if there is no pivot?
The challenge now is analysing what a Trump Presidency means for the US economy and markets. His policy platform is a collage of sometimes-contradictory pledges, often-controversial goals and occasional compelling economic insights. As with his policies towards foreign affairs, the environment and on social matters, there is widespread hope that many of Trump’s economic policies comprise a disposable means to the presidency and will not be enacted into policy. This is possible and we may hope that having achieved the Presidency, Trump will pivot towards the centre and embrace more orthodox policies. However, there is reason to be wary of such an assumption. Firstly, the election represents a remarkable success for the GOP, who will control the Presidency, the Senate and the House for the first time in 90 years. This provides a powerful base from which the Republican Party can enact its agenda. Over the past two decades the GOP has evolved a policy bias more in tune with Trump’s stated radicalism. (As an example, remember the Ryan tax plan. Despite widespread praise as being a centrist compromise, it was innately and deeply regressive and would have seen the budget deficit balloon). Secondly, Trump’s very success was founded on his role as an insurgent, and insurgents struggle to be successful when they embrace the mainstream.
Given this uncertainty it might be worth analysing the limiting extreme of the potential economic policies of a Trump presidency: what would it mean if he enacted his policy platform?
The fiscal contrast: economic rationality mixed with surging debt/GDP
Infrastructure plans are economically sensible…
Some aspects of Trump’s economic platform are rooted in economic logic. As noted above, to tackle the weakness of global growth there is a need for a greater coordination of reflationary policies, in particular of a more activist fiscal policy supporting loose monetary policy. A centrepiece of trump’s policy platform is a pledge for a large-scale infrastructure spending “at least double” the USD275bn infrastructure fund pledged by Hillary Clinton. A USD500bn package on infrastructure spending would amount to 3.1% of current GDP.
Chart 1. The US budget deficit is set to widen, and Federal debt/ GDP poised to surge
…as are the plans for student debt reform
Another aspect of trump’s economic policy platform that would be welcome is his pledge to ease the burden of student debt. As we have noted before, high levels of student debt are having an increasingly adverse impact on US economic and indeed income growth: increasingly indebted individuals in the 20s and 30s are less able to purchase homes, less able to start businesses and are more risk adverse in the labour market. (Avoiding the Big Crunch – policies to prevent a deflationary world.)Fully 72% of the rise in US consumer credit since June 2007 has been caused by a rise in student debt. Reducing this debt burden would help increase economic dynamism and inject more tension into the labour market which could help increase wages.
Chart 2. Rising student debt is a drain on the economic vitality of millennia cohorts
Concerns surround the pledged tax cuts – which are gargantuan
However, as large as a potential USD500bn+ package of infrastructure spending may be, it is not even the centre-piece of Trump’s fiscal package. The dominant fiscal aspect of Trump’s economic policy platform is a proposed swathe of tax cuts that dwarf the USD2.8trn cuts enacted by President GW Bush. Trump pledges slashing corporate tax to 15%. He also proposes sweeping income tax cuts across the board, but with a dis-proportionate share of the reductions being channelled to higher income earners. While Trump has scaled back his original ambitions – which would have valued the tax package at over USD11.3trn – conservative estimates place the revised pledges at USD5.3trn which excludes Trump’s as yet unspecified infrastructure spending. An USD5.3trn fiscal package amounts to 28.7% of current GDP. Adding in a USD500bn infrastructure package brings the stimulus to 31.4% of current GDP.
The rise in federal debt/GDP could dwarf the GFC increase
If enacted, Trump’s fiscal measures will therefore entail a ballooning of the budget deficit that would be larger than was seen during the GFC, when between end-2007 and end-2008 the deficit rose 21.7% of GDP to 84.7%. From 105.1% of GDP, US debt/GDP could rise sharply. A trump Presidency may accept this increased public debt, or it may scale back its fiscal ambitions. This could entail lower tax cuts or reduced spending commitments. From the perspective of economic growth, curtailing some of the more regressive aspects of corporate tax would be more beneficial than lowering infrastructure spending (due to differential fiscal multiplier effects) but as the Bush Presidency demonstrated, the bias of the Republican Party could see the reverse policy favoured and tax cuts prioritised.
A reversal of the long-term downtrend in UST yields would result
If the deficit is allowed to rise at the outlined pace, however, then UST yields may once again have to embed a supply premium. For many years USTs have benefitted for exceptionally strong demand-supply balance, Even the impact of the GFC surge in government borrowing was easily absorbed amid growing structural demand for risk free assets due to a wave of regulations, loose monetary policy and as declining neutral policy rates and subdued underlying inflation risks supported demand for USTs. However, a debt expansion of this magnitude may require a supply premium and an enlarged UST term premium. A bear-steepening of the UST curve would entail a tightening of financial conditions as longer-term yields rose far above the current 1.75% neutral Fed policy rate. Of course, this neutral rate will provide something of an anchor to the curve and limit the extent to which yields can rise. (Yield curves tend to pivot around neutral rates – The falling neutral Fed Funds rate, a yield curve anchor and insulation against a Fed policy error.) However, under the scenario of a dramatically expanding budget deficit and improved near-term growth outlook (which we discuss below) a 50-100+bp spread of 10yr UST yields over the neutral policy rate would be entirely possible. Moreover, such a loose fiscal policy would be expected to reverse the multi-year decline in the neutral policy rate, which bear-in mind was around 5.50-5.75% pre-GFC vs. 1.75% at present. This is a bearish backdrop for USTs
Monetary policy – tighter policy as fiscal policy takes the burden
Greater reliance on fiscal expansion would raise the outlook for US interest rates
One of our concerns was that the Fed was poised for a policy error as it tried to find reasons to tighten monetary policy at a time of subdued wage growth and inflation risks, where economic growth struggled to exceed 2% and where the neutral policy rate is falling. Trump’s stated policy package would ease these concerns. An ultra-loose fiscal policy would reduce the burden on monetary policy to support growth. An undiluted application of Trump’s policies could enable the Fed to implement its more hawkish tendencies, at least over the coming 12-18 months. More structurally, an aggressive fiscal reflation could – at least in the first instance – reverse the steady downtrend on the neutral Fed Funds rate which would provide additional headroom for the Fed to raise rates.
A new Fed Governor?
Added complexity to the conduct of monetary policy comes from Trump’s past criticism of Fed Governor Yellen and of the prevailing low interest rate policy. Were Yellen replaced as Fed governor concerns could naturally increase regarding a reduced independence of the Fed, in an echo of the pressures that the Bank of England had to fend-off post Brexit. Given that Trump has in the past criticised loose monetary policy, concerns over the longevity of Yellen could of course cut both ways in terms of influencing the outlook for monetary policy! However, the critical driver of the US monetary policy outlook were trump’s policy package to be enacted would, initially, be a far less reliance on monetary policy to support growth.
The USD – wanted lower but pushed higher by the new policy mix?
Will Trump’s polices frustrate his desire for a weaker USD?
One of Trump’s clear preferences is for a weaker USD. His embrace of trade protectionism is also linked to a desire for a more competitive currency. Nowhere is this bias clearer than in relation to China which Trump believes should be named as a currency manipulator and subject to a high tariff regime. Actually achieving the objective of a weaker USD may be complicated – initially at least – by other policy pledges. Trump wishes to attract an inflow of liquidity into the USD by offering a 10% tax rate (vs. 35% at present) on the repatriation of more than USD1trn cash holdings held overseas by US corporates. In addition, were an ultra-loose fiscal policy to be enacted, the consequence of higher UST yields and – other things equal – an outlook for tighter monetary policy would be supportive of the USD. The irony is that while Trump favours a weaker USD, were his policy package to be enacted in full one could envisage the foundation for a pronounced period of USD strength, one with echoes of the Reagan phase of USD appreciation. This is a highly counter-consensus but possibly flows from a stated policy mix.
Emerging market currency crisis to follow
USD strength would of course not necessarily be uniform. In an uncertain world, demand for traditional safe haven currencies such as the JPY and CHF could be supported, especially since the Bank of Japan enacted its internally inconsistent new policy framework which over time may limit the potential for JPY weakness. (The Bank of Japan’s new policy framework and Jar Jar Binks.) In contrast, emerging markets could face the brunt of trump’s economic policies and could see their growth outlook sharply reduced as the recent reversal in globalisation accelerates.
Economic growth – a sugar rush upsurge vs. an end of globalisation?
A surge above 2% GDP growth at last
If enacted, Trump’s policy package has the potential to see US economic growth achieve the 2+% levels that have proven so elusive for a sustained period of time post-crisis. A dramatic fiscal expansion and initial boost to disposable incomes as taxes are reduced would naturally be positive for economic growth. We have long clamoured for a larger role for fiscal policy in supporting aggregate demand in the US and indeed across the G10, and the phrase “be careful what you wish for” springs to mind. Moreover, the weakness of income growth could also be eased by protectionist economic policies providing a fillip to US rust-belt industries by increasing domestic labour demand.
Chart 3. Trump’s fiscal expansion could, if enacted, notably raise US GDP growth. Intially
Offsets to growth
However, there are critical offsets, which could erode the positive growth consequence of the trump policy platform:
- One of the more alarming aspects of Trump’s victory – and to a lesser extent, also of Brexit – is that it heralds a rejection of the policy of globalisation and liberalisation that has dominated economic thinking for the past 40 years. Trade protectionism is a policy that in the first instance can increase domestic incomes (or at least slow the decline in incomes on sunset industries) but comes at a longer-term consequence of slower global growth. Global trade growth has been shrinking in recent years, which reflects both weak global demand but also how globalisation and liberalisation are already in retreat. Trump’s victory could accelerate this reversal. This is clearly a negative for global growth and, despite the strength of the US domestic economy the country is not an island unto itself. While Mexico and the Ukraine are two countries most obviously at risk from Trump’s trade and foreign policy biases, the circumstances of China also bear close consideration. Trump favours Beijing implementing a strong-CNY policy and he also wishes to reduce the US bilateral trade deficit via any practical means necessary. Such policies would prove deflationary for a highly levered Chinese economy already struggling with a structural economic slowdown. This policy could be the spark to the non-linear economic slowdown we have feared in China. (The weak CNY and the potential for a trend acceleration.) An economic and financial crisis in a country which has accounted for around a third of global growth since the GFC, is clearly an event that would impact US growth.
Chart 4. China has dominated global liquidity and leverage growth since the GFC. A bad time for deflationary policies to be imposed on a structurally slowing economy
- Lower taxes and increased government spending would clearly be supportive of corporate investment. However, the rise in UST yields were the Trump package to be enacted would raise the required internal rate of return on new investment decisions. Moreover, other policies woud create an enlarged risk premium. Trade protectionism would adversely affect elements of the US corporate sector that has invested heavily overseas, particularly in China. Moreover, Trump’s foreign policy pledges lay the foundation for increased geopolitical tensions, most notably his suggestion that NATO could no longer be underpinned by a mutual defence pact. However, these factors would slow the responsiveness of growth to fiscal stimulus rather than prevent a positive reaction. After all, while Trump’s policies may create a climate of an elevated risk premium, the potential for 15% corporate tax rates would provide a notable offset to weaker corporate sentiment.
Chart 5. US employment cost index: wage growth has lagged the labour market recovery
- As noted above, trade protectionism can initially boost incomes and employment in sunset industries. One concern is of course whether the rise in income growth will be notable. After all, a critical problem in the US (and OECD) economy is a reduced pricing power for labour. This has been one factor reducing the sensitivity of wage growth to low levels of headline unemployment. (Under-estimated surplus labour is another factor). Moreover, growth in employment in sunset industries is unlikely to be a factor that can improve the laggardly levels of productivity that is an additional explanation for weak wage growth. The responsiveness of wages to the new policy package could disappoint just as income growth has lagged expectations as the labour market has recovered. (The income-lite recovery trend – does the UK labour market portend weak US wage growth?.) Beyond this initial effect, slower global trade growth could increasingly erode US growth – and through extension, the outlook for wages.
Chart 6. Trade protectionism will do little the reverse the US/ global slowdown in productivity
The impact of a President Trump that does not pivot
An early 2017 bounce in economic growth and risk assets
Of course, the above analysis assumes that Trump enacts his full policy platform. We would expect there to be a notable watering down of the eventual policy package which could render much of the above scenario analysis moot. However, the analysis looks at a limiting extreme for the ways in which Trump’s platform could impact the economy and markets were it enacted in full. The fiscal expansion and the associated impact on US GDP growth and the implication for monetary policy are deeply negative for USTs, at least into 2017. Moreover, the surge in growth and sharply lowered corporate tax base could initially support risk assets. The outlook for embattled financials in particular would be transformed as they go form a climate of increased financial repression to rising market volatility and increased UST yields. Meanwhile the preference for a weak USD might struggle to be achieved set beside Trump’s fiscal-monetary policy mix and the desire for overseas liquidity to be repatriated into the US. Counter-consensus as it is, a full Trump policy package could initially, during the expected blizzard of activity during Trump’s first 100 days, be highly positive for the performance of US risk assets and the USD. (The weeks leading to the trump Presidency may of course be very uncertain as the market ebbs and flows between judging the extent to which the president elect will pivot to centre. Short-gamma trading strategies would not be advised over this period)
It would no longer be better to be an exporter of deflation
However, this is not a sustainable outcome. The longer-term consequence of the US leading the world’s accelerated advance from 40 years of globalisation and liberalisation has a longer-term economic and market consequence that should not be under-stated. Slower global growth both actual and trend – would result. The efficiency of capital allocation would decline. The current weakness of OECD productivity growth would be exacerbated. And critically, many key emerging market economies – most notably China – who have become fully enmeshed in a global economy could see a reduction in their growth potential sufficient to create a domestic financial crisis. Trump’s economic policies could, in the case of China, test one of our core thesis: that it is better to be an exporter rather than an importer of deflation only as long as trade protectionism does not emerge. If it does, surplus global capacity will be wiped-out at source, in the capital exporting countries, This is a deeply deflationary outcome for many emerging markets. For these reasons, the possible positive US risk asset reaction to trump’s economic policies should not be chased too long or too readily. The seeds of a global emerging market crisis could today have been sown.
Hope for a pivot, and if not make the most of the sugar rush phase of growth
For now, however, we wait. We wait for signs of how committed Trump is to his policy platform or whether he will pivot to the centre. We wait to see whether his fiscal package will be scaled back and how the balance between tax cuts and spending increases will be played out. We wait to see whether Trump will step back from his more aggressive policies of trade protectionism. We do not know. So much depends on the answer. But at least we can look at the possible economic and market reaction if Trump does not pivot to centre.