Recent moves in the market have been as surprising and disorienting as the election of Trump itself. For what it’s worth, here is my take.
Miraculously, a Trump victory has accomplished what central banks around the world have been laboring to accomplish for the last two or three years--persuade the world to believe that inflation is on the up and up. This persuasion in turn gives monetary policy traction again—by making nominal interest rates more deeply negative in “real” terms. In lockstep, fixed-rate sovereign debt (along with equity look-alikes) has tanked. Has the so-called fiscal cure arrived? Paul Krugman is sputtering with indignation that this uncouth right-wing charlatan has stolen all of this progressive thunder.
The new narrative now dominates the thinking of global investors. And apparently markets think that Trump’s “huuuge” fiscal push could be big enough to overwhelm any developing late-cycle deceleration in the economy. The fact that Trump also wants to steamroll regulatory obstacles for energy, heavy industry, banks, and pharma simply adds another sectoral "spin" to the rally.
So does the Trump rally have legs? Will it continue to power global markets upward in fits and starts until the President-elect in sworn in on January 20?
Personally, I very much doubt it. Keep in mind that the new narrative is only six days old. A new narrative could just as quickly replace it. Here are a few alternative scenarios that could displace Trumponomics:
Signs Trump won’t be able to pass or implement his expansionary agenda.
Keep in mind that there are a whole lot of Republicans in Congress (both traditional and Tea Party) who don’t favor reckless deficit spending and adding another 20-30 percentage points of GDP to U.S. federal debt. The debate here has yet to begin. A possible House balking at the debt limit ceiling this spring could bring the whole Trump train to a stop real fast.
Spasms of anti-growth populism.
To date, global investors are focused on all the policy measures—fiscal stimulus, tax reform, deregulation—which get lots of support from a wide range of economic experts. But what about the other stuff: unilateral tariffs against China and Mexico, rounding up millions of “illegals,” telling Poland or South Korea either start paying “your own way” or we’re history? Trump may not want to act like a bull in the China shop, so to speak, but he has a movement to feed. He has followers to favor. He has midnight tweets he needs to fire off. It’s easy to imagine a firestorm that could eclipse all of his well-wrought fiscal and regulatory plans.
Further evidence of U.S. growth slowing.
Expectations and markets can turn on a dime. The real economy lumbers on, like a supertanker, requiring two or three quarters of hard-about steering to change its trajectory. Further deceleration in employment, industrial production, retail sales, personal income, or sentiment could quickly turn markets around no matter what news comes out of Trump’s transition team. (See: Obama’s 2008 inaugural address.)
New evidence of global trouble.
In three weeks, in case no one has noticed, Italy will vote on a constitutional overhaul that (should it fail) could bring the nation to its knees—and Austria is likely to elect a right-wing nationalist as president. Emboldened by Brexit and Trump, nationalist “alternatives” in France, Germany, and the Netherlands will all be running for national leadership in 2017. Meanwhile, the Trumpian boost in the U.S. dollar is hammering the EMs. And did anyone forget that the global economy has been slowing down over the past two years? Then let’s add on the extra $20 in the price of oil should Trump unplug the Iran agreement. The bad news that stops the Trump rally may not be home grown.
The failure of success.
OK, let’s imagine that Trump clears all of the above hurdles. His deficit-fueled program is certified by Congress, he avoids tariff wars, and he is blindsided neither by “slowth” in the U.S. economy nor by financial crises abroad. The final question is whether global financial markets can actually survive Trumponomics successfully deployed. Can inflation expectations, long-term rates, and debt-to-GDP ratios (the rates and the ratios feed off each other) keep climbing without triggering a collapse in high equity valuations? Can wages push higher (four more states approved higher minimum wage laws on November 8) without squeezing earnings? Can the dollar and U.S. yields both keep rising without starving the EM economies of investment funds?
And that’s just for starters. There may be several other scenarios I'm not thinking about. I’m sure we’ll have reason to discuss them soon.
