Heightened uncertainty
Trump's election introduces significant uncertainty to the outlook for government policy, economic activity and the US Federal Reserve (Fed). Market volatility has spiked in reaction to the result and we expect this to continue over the coming weeks amid speculation about his likely policy agenda. However, we stress the importance of not overreacting and waiting for clear announcements of priorities.
Prioritising tax cuts and looser regulation
The president-elect and House Republicans have placed large tax cuts and corporate tax reform at the heart of their fiscal agenda. Mr Trump has also advocated a large increase in infrastructure spending. With Republicans also controlling the Senate, this implies a likely loosening of fiscal policy from late 2017 and into 2018, though fiscal conservatives in Congress may seek some offsetting cuts to other areas of discretionary spending. There is a strong prospect that the regulatory noose will loosen across finance, energy, telecoms and healthcare sectors.
Trade policy will be pivotal for the economy
At face value, the above policy agenda would boost economic activity over the next two years. However, Trump has pledged to increase trade protection and reduce immigration - policies that would simultaneously weaken economic growth and increase inflationary pressures. It is plausible that the new administration will not ramp up tariffs on Mexican and Chinese imports, content instead to bury the prospect of new trade agreements and make more use of enforcement clauses in existing agreements.
And the Fed...
Under that scenario there is a greater chance the Fed delays increasing US interest rates into 2017, awaiting more clarity on the market and policy outlook. However, once the noise dies down and it becomes clear that fiscal policy is set to become more expansionary, the Fed would likely recommence lifting its policy rate and at a faster pace than would have been the case should the Obama administration policies been maintained.
Should President Trump prove to be serious about pursuing a more protectionist policy agenda, the negative consequences for economic activity and corporate margins could easily offset the benefits of fiscal easing. This would prevent the Fed from increasing interest rates for some time. With particularly disruptive outcomes, the Fed may even consider easing policy. The subsequent effect on inflation expectations and unit labour costs would determine when and how much the Fed tightened once the turmoil subsided.
Market implications
The result has led to a significant ‘risk-off' move in markets, with short-dated bonds rallying modestly and risk-assets, including equities, declining substantially. The US dollar has been broadly stable on a trade-weighted basis however it has depreciated against the major developed currencies and appreciated against emerging market currencies, especially the Mexican peso.
A downbeat mood could last several weeks but, as noted above, the medium-term implications for markets depend on the actual policies of President Trump and what can be negotiated through Congress. The direction of the US dollar will be influenced by a number of forces in the medium-term, including whether fiscal policy is loosened and a repatriation tax is implemented, as well as the shape of trade arrangements. We expect government bond markets to be supported in the near-term but, as is the case for the dollar, the medium-term impact will depend on the policy mix.
In equities, once volatility subsides, lower corporate taxes and looser regulatory policies could provide a lift to markets. However, any increase in the US dollar or higher interest rates would be negative. This environment is likely to create opportunities for ‘bottom-up' stock-picking in both equity and bond markets. Even in a benign trade policy scenario, firms with extensive global value chains, or reliant on migrant labour, would face a more uncertain future, while firms facing less onerous regulatory requirements stand to benefit. If the new Trump administration pursues an aggressive unwinding of polices that have supported globalisation, an extended period of weakness for risk assets is likely.
Clearly it is too early to fully assess the implications of the election result on markets, politics and the economy. However, Standard Life Investments will be providing clients and investors with continual updates when there is more clarity on the policies of the new Trump administration.
