The Macro Report | November 2016

The United States changes course


Under a Trump administration, how will the government balance macroeconomic policies that support growth against policies that restrain it?

In the run-up to the U.S. presidential election, markets were beginning to expect some changes in global monetary policy. The Fed was expected to hike in December, and there was some serious discussion that the ECB might not extend its QE beyond March of next year. Meanwhile, the Bank of Japan was signaling it was prepared to stay on hold, and the Bank of England, having acted swiftly after the Brexit vote in June, seemed to pause before making its next move. With the world economy modestly improving, and some commodity-induced inflation in the pipeline, markets were beginning to prepare for a new policy regime in which interest rates would edge higher.

Trump’s victory has changed all of this by ushering new uncertainties into the global economic arena. Trump will take office in January with a Republican Congress. While it appears true that the President-elect’s relations with many senior Republicans are strained, we would submit that Trump’s convincing win will not fail to impress them. After all, he delivered states into Republican hands that have been out of their reach for a generation.

Trade to be the new fulcrum of U.S. economic success or failure
But when we begin to consider how campaign promises can be translated into policy, the surety of Trump’s authority is beset by important questions. What, for example, will happen to trade under Trump? How will relations with China and Russia evolve? Will the “wall” between the United States and Mexico be made of concrete and rebar, or will it take the form of more border control agents driving around in (U.S.-made) SUVs? Or will it be metaphorical and take the form of a very different immigration policy?

So much of corporate decision making over the past 30 years has been built on the idea that trade barriers were steadily being reduced, but this trajectory may now have changed. We would note that the situation in the United States matters far more than Brexit, where the uncertainty concerns trade relations between the United Kingdom and Europe. Now, we have uncertainty over trade relations between the world’s biggest economy and the rest of the world.

Generally speaking, trade is associated with productivity growth. Erecting barriers to trade raises domestic prices and hits growth in the short and long run. Of course, the details of trade relationships matter a great deal, and we know virtually nothing about the details that could emerge under Trump. In our view, his campaign rhetoric on trade included ideas that would be harmful to growth in both the United States and the rest of the world.

There are serious divisions within the Republican Party on these questions, and because Trump has neither deep knowledge nor experience with policy making, it is unclear just what will take shape. Throughout his campaign, Trump resisted being co-opted by Republican “insiders.” We have no reason to believe this will change. In our view, the more probable scenario is that mainstream Republicans move toward Trump, rather than the other way round.

Policy tilt: Growth positive or growth negative?
In the short run, we think Trump’s victory means that significant U.S. monetary policy change may be temporarily off the table. Meanwhile, uncertainties in key areas, such as trade, could stay with us for some time. Pressing priorities for the incoming administration — such as Trump’s promise to “repeal and replace” the Affordable Care Act — will likely soak up no small amount of political oxygen in the near term.

But there is another area where we could see more rapid action: tax reform. One of the very few things on which all Republicans agree is that personal tax rates should be cut. This may well be linked to business tax reform, but the more ambitious the reform, the longer it will take to get through even a sympathetic Congress. After all, there are many vested interests at stake. The tax proposals on Trump’s campaign website have been estimated to increase the deficit materially, even with “dynamic scoring” — that is, allowing for the possibility that the tax reforms could stimulate growth.

In the past, the tax reform discussion has always linked tax reform to entitlement reform in order to contain the fiscal impact, but Trump has opposed changing Social Security quite strongly. While we do not know how this will play out, we think it is likely that the fiscal deficit will increase in the next year or two. Proposals for increased infrastructure spending would add to this, and increased military spending is also highly likely.

Will all of this be growth supportive? Lower taxes and higher infrastructure spending will boost growth. But uncertainty over the trade regime is likely, in our view, to harm corporate investment. As we learn more about Trump’s transition team and its priorities, the implications for policy should become clearer.

Trump may routinely test investors’ appetite for risk
As of mid-November 2016, the market appears to have defied pre-election suggestions that a Trump presidency would lead equities to sink. We believe this indicates that the market is — for now, at least — underestimating the potential of Trump’s agenda and policies to undermine economic growth. What’s more, if Trump ends up abrogating trade agreements, some real effects could be delayed six months or longer, which could prolong bullish Trump bets. By contrast, the effects of spending initiatives and tax cuts could begin to be felt in the first six months of his term, possibly buttressing the growth-positive interpretations of Trump’s policy trajectory. But to us it feels premature, and possibly shortsighted, to bet too heavily that the incoming administration can accelerate economic growth.

On balance, we think the Trump victory initially may mean a much larger deficit and some upward pressure on inflation. As of this writing, the risk premium in the Treasury curve is being restored. Overall, though, it is not clear whether asset prices in general reflect the new uncertainties spawned under a Trump presidency. On our risk appetite measures, October was not a strong month, and some of the internal features of asset class performance made us think that a Fed move in December would cause some short-term difficulties. We think that, in the short term, monetary uncertainty has dropped, but uncertainty over the policy environment as a whole has risen. This could matter a lot for risk appetite as the policy landscape comes into clearer view.


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