Trump victory: after initial boost, weaker growth and higher inflation likely

Schroders

Donald Trump’s victory in the US presidential election could lead to trade wars, with tariffs likely to rise.

Congratulations to Donald Trump who has defied the odds and the naysayers to become the oldest elected president of the US.

This is an extraordinary achievement for a Washington outsider who had to beat 16 others for the Republican nomination, as well as a seasoned politician like Hillary Clinton for the presidency. Meanwhile, commiserations to Hillary for whom the election was hers to lose. And spare a thought for the opinion pollsters whose reputations lie in tatters.

Investors must now absorb the reality of a president who has promised to create 25 million jobs and build a wall across the border with Mexico.

High probability of trade wars

President Trump’s fiscal policies will cut taxes and spending, but will most likely lead to higher interest rates, inflation and a bigger budget deficit. We would expect Congress to temper the new president’s fiscal plans, while he will have more freedom on trade. Consequently, we are likely to see modest fiscal stimulus and a trade war break out as the president raises tariffs on China and Mexico.

The net effect is that after a brief boost from tax cuts, the economy will cool as inflation and interest rates rise. With higher tariffs pushing up prices and wages rising as immigrant labour supply falls, the overall outcome is likely to be stagflation, i.e. weaker growth and higher inflation.

Volatility likely as low rate environment unwinds

This is unlikely to be favourable for markets: bond yields may rise as investors seek greater compensation for inflation risk, while equity markets are expected to de-rate.

We are likely to see significant volatility as the low rate environment of recent years, which has supported equity valuations and driven the “bond proxy” stocks, unwinds dramatically.

Cuts in corporate tax rates will offset some of this and sectors such as energy and financials could benefit from reduced regulation.

More broadly, the prospect of protectionism and lower global growth will hit equity markets and risk assets worldwide. Emerging markets are particularly vulnerable given their dependence on global trade.

Safe havens in demand but dollar outlook uncertain

It is not clear how the US dollar would behave in this environment. Some see a stronger currency driven by higher yields, but as this will be accompanied by higher inflation such a conclusion is not obvious. In addition, many investors may be deterred by a deterioration in US foreign relations with the rest of the world.

The best bet is that safe haven currencies such as the Japanese yen and Swiss franc are likely to be in demand and investors are also likely to favour gold.

 


The above article by Keith Wade, Chief Economist & Strategist at Schroders was first published on 9th November 2016.