Tuesday will mark “7 Days Later” for the US.
No, we didn’t a zombie apocalypse last week, but we did witness the next worst possible turn of events: Donald Trump became President elect in what one can pretty safely call the greatest (or “worst” depending on how you look at things) political coup in American history.
Equity markets responded by staging their biggest rally since 2011 and the bond market puked to the tune of $1 trillion in what’s being dubbed the great “reflation trade.” In short, investors expect a Trump presidency to be accompanied by massive fiscal stimulus or, helicopter money, which is perversely appropriate consider Trump’s penchant for arriving in style…
It’s not clear how receptive Congress will be to Trump’s plans, but if the last 12 months have taught us anything it’s that one shouldn’t underestimate Americans’ propensity to be stupid. Throw in the fact that central banks seem keen on stepping back from their role as masters of the post-crisis universe and you’ve got yourself a rather interesting setup.
Here with a Sunday evening breakdown is Bloomberg’s Daniel Kruger:
Count this among the ways that Donald Trump’s election has rocked the financial world: monetary policy is no longer in charge. The president-elect’s proposals for significant commitments to spending and tax cuts have shifted the burden of stimulating growth from central banks, for the moment at least.
“The market’s been looking for the fiscal theme to take over,” said Deutsche Bank’s Alan Ruskin. “The burden of responsibility has shifted,” with those who doubt the market’s recalibration being the ones who need to prove their case
That accounts, in part, for the enthusiasm for equities and commodities. Expectations of faster U.S. inflation are also spreading to Europe and Japan as seen in rising breakeven rates
Trump may get some of the spending and, especially, the tax cuts he wants from Congress. Whether these will have the effect the market is now betting on remains to be seen
Trump will be pushing against an economy that is on a lower long-term growth trend in what many economists call “the new normal.” As a candidate, he promised an expansion of 3.5% or faster. If it doesn’t materialize, will he double- down on his policies?
The upward surge in bond yields across the curve, inflation expectations and the dollar may complicate Trump’s plans. Futures show traders are locking in bets on a December rate increase. It’s possible that tightening financial conditions may slow the Fed from further moves until stimulus bears fruit
But monetary policy is no longer what’s driving these moves. Increasingly, central banks may see themselves in a defensive role, reacting to events rather than dictating trends. The greenback’s rally is already forcing Asian and Latin American central banks to protect their currencies. More such moves may be in the offing if dollar gains continue
Will Europe and Japan turn to the Trump model in an attempt to boost growth and inflation in ways monetary policy hasn’t? Europe may have a limited ability to increase spending, while Japan has essentially exhausted that growth channel, too, said Robert Tipp of Prudential
But for now, after growing weary of monetary-led slow growth, markets are grasping at Trump’s answer to the New Normal
And here’s some commentary from the aforementioned Alan Ruskin over at Deutsche:
The prospect of sizable fiscal stimulus has appropriately revived the longer term prospects for a stronger USD. One wrinkle in this story, is whether the Trump administration will resist USD strength? The above question has its root in the logical tensions between a protectionist trade policy and a potentially ‘uncompetitive’ exchange rate. It would be damning were protectionist policy to help the trade balance by suppressing imports, only for an ‘overly strong’ exchange rate to hurt exports and boost imports, resulting in a sharp deterioration in the trade accounts.
A strong USD is potentially a vital disinflationary offset to likely reflationary fiscal policy enacted when the economy is already at full employment. Not allowing the exchange rate to play that ‘safety valve’ role, would risk a further blow-out in bond yields. We believe this is one of the more persuasive arguments for avoiding the temptation to use a weaker currency to support manufacturing employment in current circumstances. Not only is exchange rate policy in potential contradiction with trade policy, but trade policy is in some ways in contradiction with fiscal policy, since fiscal stimulus will also lead to a deterioration in the external accounts. The external accounts, often mentioned in Trump’s political campaign, will be a terrible measure of the success or failure of macro policies, since they are likely to deteriorate significantly as US growth picks up relative to her trading partners, regardless of protectionist policies.
Good questions, all but I imagine Trump will have little interest in academic debates about his policies. He’s going to make America great again and you should just shut up and accept it…