For the second time in 2016, the global geo-political landscape has shifted dramatically (and traditional opinion polling has been shown to be severely lacking), with the election of Donald Trump as the 45th President of the United States.
Importantly, Donald Trump won a majority of the Electoral College votes. With a majority of 270 College votes required, Donald Trump has won 279 (as at approximately 7am Sydney time) and is likely to win the last two states, Michigan and Arizona and their 16 and 11 electoral college votes respectively, to finish with 306. His unexpected victory has been achieved by flipping several blue states that had previously voted for Obama in 2012, including Pennsylvania, Ohio, Michigan, Wisconsin, Iowa and Florida. While Trump was expected to do well in the rust belt and former manufacturing heartland, this outcome is far beyond what anyone expected.
Indeed, in addition to the victory by Donald Trump, the Republican Party has retained a majority in both the Senate and House of Representatives. The Senate and House results are still being finalised but at this stage, it looks like the Republican Party is likely to have a 52/48 majority in the Senate (down from 54/46) and a 239/196 majority in the House of Representatives (down from 247/188).
President Trump’s policy priorities
As we noted in our previous US Election blog (2 November 2016), Donald Trump’s priorities are expected to be:
· Tax reform: including a substantial reduction in both income tax (down to three basic rates, 12%, 25% and 33%) and cuts in the company tax rate to around 20%-25% (from 35% currently).
· Health care reform: Repealing Obamacare with a focus on reducing costs and entitlements.
· Defence: Increased spending on both Defence (US$450 billion) and Veteran’s programs (US$500 billion).
· Trade policy: A much more aggressive trade policy, including naming China as a currency manipulator and imposing tariffs on selected Chinese imports, changing the terms and conditions and North American Free Trade Agreement (NAFTA) and abandoning the Trans-Pacific Policy. We would note, however, that there is considerable uncertainty of whether Trump as President could act unilaterally on trade policy, or whether he would need the support of Congress (which may not be forthcoming) to change policy, especially treaties such as NAFTA.
· Immigration reforms: Reduce the flow of both legal and undocumented immigrants, including some deportation efforts and much tougher rhetoric.
· Infrastructure: An infrastructure spending program of approximately US$300 billion over coming years.
· Other: Housing finance reforms, loosening M&A regulations, loosening media ownership and liberalising energy drilling requirements, reversal of some climate change policies.
Implications of President Trump’s policies
It is our view that, over time, Donald Trump’s policies would, as announced, be highly stimulatory, expansionary and, ultimately, inflationary.
In terms of implications for financial markets we see three phases for the period ahead – but with less confidence on the exact timing of these trends.
1. The initial market reaction, globally, was ‘risk off’. Global equities were down, the USD was down against other major currencies and US Treasury bond yields were down. This is a very similar reaction to that seen after the ‘Brexit’ vote.
At one stage in the US (late afternoon on 9th November AEST), the S&P and NASDAQ Futures were down 5%, the maximum drop permitted by the Chicago Mercantile Exchange before trading curbs are triggered. Globally, the Japanese Nikkei closed down -5.4%, Hong Kong’s Hang Seng -2.2% and the ASX200 down 1.9%.
However, once US markets opened, the ‘risk off’ sentiment quickly reversed with most equity markets closing higher, UK FTSE100 closed up 1% while the Euro Stoxx 50 index was up 1.1% and in the US the S&P 500 is currently trading around +1.1% while the Dow Jones is 1.4% higher.
In bond markets, much like equity markets, we saw the initial ‘risk off’ sentiment quickly reverse as US markets opened and yields rose sharply on the result, with US 10yr yields up 20bps to 2.07%. Initially Australian 10yr bonds were down 14bp to 2.21%, but in overnight futures trading yields have increased 29bps to 2.49%. In currency markets, the USD initially weakened with the DXY index at one stage down 2.1% before recovering through US trading to be up 0.76% on the day. The Mexican Peso is down 7% against the USD, which has been seen as a proxy for a Trump win given his rhetoric around Mexico. The USD finished stronger against most currencies, with the US up against the Yen (+0.72% to 105.8) and Euro (+0.75% to 0.914) but down against the Pound Sterling (-0.38% to 0.804). The AUD is weaker by 1.1% against the USD at $US0.765.
The ‘risk off’ mode was based on the view that Donald Trump is a vote for significant change in the US political system. This change will likely bring uncertainty and, as we know, markets do not like uncertainty. However it is fair to say that phase one has been shorter than expected.
2. The second phase of the market reaction, which appears to have begun sooner than we anticipated, is likely to be ‘risk on’, with positive sentiment towards equities and weakness in bonds. This is based on the view, as already mentioned, that Donald Trump’s policies are very stimulatory, expansionary and inflationary.
If he was able to get is election policies through Congress (which could be more likely given the Republican’s majority in both the House and Senate), we are likely to see a near-term acceleration in the pace of growth of the US economy and a surge higher in the USD.
The equity markets could potentially respond positively to this stimulus – especially those with significant cash holdings off-shore and those companies involved in sectors of the US domestic economy that stand to benefit from Trump’s nationalistic policy focus.
3. Phase three of response to President Trump’s policies are, not likely to be as supportive. The key issue here, in our view, is that the inflationary implications of Trump’s policies are likely to see the Federal Reserve raise interest rates much more aggressively than currently priced into markets as inflation takes hold.
This could be expected to see Treasury bond yields move sharply higher – short-circuiting the stronger economic data. Trump’s anti-trade policies and commitment to increasing tariffs are also likely to be inflationary and negatives for growth.
The implication here is that, perhaps within a year or so of President Trump’s policies being introduced, the US economy could weaken significantly (possibly head towards recession), with the USD, bond yields and the equity markets all likely to decline as well.
– Stephen Halmarick, Chief Economist at Colonial First State Global Asset Management (CFSGAM).
