President Trump: Policies and Expectations
8th November 2016, a day hard to forget. A candidate many thought impossible to be elected President of the United States at the beginning of a bitter election campaign stumped voters, the media and sent shockwaves around the world. What delivered Donald J. Trump into the highest office in America can be attributed to the discontent of white working-class American men that saw in him a breath of fresh air. It was a protest vote against the system, against politicians distant from every-day problems and pork-barreled politics. Taking a step away from the political and social unrest that lead to this unexpected victory, it is important to consider this event on a global scale and especially on the expectations and reactions of financial markets.
What markets were expecting?
The Predictit market (the real money political prediction market) had Hilary Clinton winning with 77% probability. We usually look at bookmakers because we are of the idea that “smart money” can assess all the information far more efficiently than opinion pollsters or journalists, and thus less biaised. Bookmakers were not the only ones that had it wrong: financial markets and mainstream media outlets also called the election the wrong way.
Just two hours before polls closed, currency markets were expecting a Clinton win and were considering a Trump win merely as a distant, implausible event. Bloomberg explains that the dollar was expected to rise with Clinton as President-elect, and a declined was predicted, following a Trump win. Indeed, before the final result was known, the dollar rose.
This is not the first time that the market has been dumbfounded by a current event. This is similar to shock the world woke up to after the Brexit vote.
The numbers after the election
Although investors’ expectations were confounded, it seems like they learned a lesson from Brexit. As a matter of fact, in the days before the election, trading volume declined. A crash that many had feared with a Trump win was avoided. Even though futures prices went down right after the election, US main stock indexes closed high on Wednesday. To have a clearer idea, these were the numbers: on Wednesday the Dow Jones Industrial Average climbed up 1.4 percent and the Nasdaq composite added 1.1 percent. US stock markets reacted better than expected, but the numbers were more pessimistic for all other markets around the globe, with Asian stocks and European banks affected by the election outcome.
In spite of the above-expectation day on the stock market, analysts were predicting that a widespread sentiment of uncertainty would weaken the US dollar and increase investment in ‘safer’ assets, such as investment grade government bonds or gold. If this was the case, big investment in US government bonds and T-bills could greatly undermine the plan of the Fed to rise interest rate in December.
However, not even this prediction was accurate. The yield on the 10-year Treasury note jumped by the most in more than three years on Wednesday. This event was the outcome of a big sell-off that followed the election. This seems to suggest that, after initial fear and uncertainty, markets seemed to accept the election outcome.
But how is this possible? How can it be that a day that had the potential to become the “black Wednesday” is now going to be deemed as a relatively good day for financial markets?
What is Trump offering?
The package that Trump is selling and that most Americans, and apparently also investors, seem to buy is a collection of policies that would undertake a fiscal expansion. The policy that, as candidate he advocated the most, was a tax cut. This tax cut would mainly benefit the rich elite and big corporations by cutting corporate taxes from 35 percent to 15 percent. Applying the trickledown effect, he believes this would stimulate the overall economy.
Trump has clarified that there is no more room to maneuver for monetary policy; on the other hand, fiscal and supply-side reforms have still a lot to offer to stimulate the economy. These measures include: infrastructure spending, tax reforms and deregulations to stimulate growth. The market has a lot of faith in his proposals and the inflation expectations have risen as a result of the promise of higher government spending.
The stimulus program his team is working comes at a time when the US is already close to full employment. This would mean higher growth and higher inflation. The tax cut proposed would add to the federal debt $7.2tn over the first decade, according to analysts from the Tax Policy Center. To this we need to add the investment of $550bn in infrastructure. This would represent a big shift in policy at a time when most institutions, including the International Monetary Fund, are in favor of greater fiscal restraint. This is not the only institution that Trump disagrees with.
Trump has not tried to hide his criticism towards Janet Yellen and the latest Fed policies.
Populists around the world have been criticizing central banks for their ultra-stimulative policies. These have in fact deepened inequalities in society and penalized savers. It seems like Trump is sticking his nose Fed’s monetary decision and this would undermine one of the most important prerogative of central banks: independence.
Trump’s trade policy
But was the pre-election market fear for a Trump win reasonable? Or is the market correct now not being too pessimistic? It is difficult to assess with certainty the policies that Trump will carry out because he was never too detailed in his campaign. However, something was often promised in his speeches: restriction of free trade. It is, therefore, hard to believe that the new President will complete new trade deals, but easier to believe that old ones will be reformed or scrapped, with negative repercussions for capital markets and for the economy as a whole. The American economy depends heavily on access to a global supply chain and China and Mexico are central actors. Nonetheless, President-elect Trump claimed he wants to implement higher tariffs on Chinese imports and punish American companies that manufactures in Mexico. The outlook for global trade growth is darkening considerably.
Trump also promised in his campaign to rip up or re-negotiate the North America Free Trade Agreement. If he achieves the goal of taking the US out of NAFTA, it would threaten the elaborate North American supply chain many US companies rely on. A central theme of his election platform was to combat unfair practices from China, such as dumping practices. He said he would do this by implementing punitive tariffs. This protectionists behavior may ignite a tariff war that many economists predict it would bring the US back in recession. Higher tariffs on Chinese imports will help neither consumers, that will be facing higher prices, nor firms that depend on Chinese imports. It would also be an unprofitable policy for farmers and other businesses that rely on China as an important export destination.
Trump will not be sworn in as President until early 2017 and markets will have some time to forecast on possible scenarios and correct themselves. Since electing Clinton meant keeping the status quo, investors had already priced in her presidency and knew what to expect. With Trump, nothing is sure and uncertainty is one of the worst enemies of financial markets. All markets can do now is wait and see if and how global economic dynamics might change. While markets avoided a big storm on Wednesday, a hurricane might be brewing in the horizon.
WRITTEN BY ELEONORA BARBIERI FOR BESA
PLEASE DIRECT ANY INQUIRY TO AS.BESA@UNIBOCCONI.IT
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