President-elect Trump campaigned on an agenda of increased government spending, lower taxes and regulatory rollbacks, among other topics. At this point, it’s impossible to know which policies he’ll actually put forward, how they’ll change on their way to implementation, and – especially unclear – how they’ll fit together to collectively impact the economy in the USA and in the world. What is certain is the role of the US in the global economy might look different than it has so far.
Relative-good vs. absolute-good economy – the inherited economy
President-elect Trump will assume responsibility for an economy in relatively good shape. Real GDP growth is trending at around 2%. The unemployment rate is holding steady at 5%. Employers have added jobs for 73 consecutive months. Wage growth is picking up, and with global trade holding down inflation, so is the purchasing power of US households. Poverty rates have fallen and real median incomes are on the rise again after struggling for years. Meanwhile, low-interest rates allowed the US to absorb most of the commodity price collapse and are supporting investment and consumption. Acknowledging the economy’s ability to withstand higher interest rates, the Fed expects a 25 basis point rate hike in December.
That’s not to say the economy has a clean bill of health, though. What’s ailing it is mostly chronic in nature. Despite years of ultra-accommodative monetary policy, growth is underperforming its long-term trend. The composition of growth is narrow: only consumers are adding meaningfully to the topline. What economic gains are being achieved aren’t being shared equally. The number of involuntary part-time workers and long-term unemployed remains high. There’s no credible plan to rein in rapidly rising government debt burdens. And productivity growth has been dismal, meaning slower economic growth is now the new normal. Though the economy has proven resilient, with that comes less margin for error and more vulnerability to shocks. This is the relative-good vs. absolute-good economy that Donald Trump inherits in January.
Markets reacted to Donald Trump’s election
Financial markets have immediately reacted to President-elect Trump’s announced policies. Within the first few trading days, equity markets moved higher while bond markets sold off. While both are forward-looking, equities tend to focus on nearer-term future earnings while fixed income orients around risk over a longer time horizon.
The post-election bond market selloff has the 10-year Treasury rate up roughly 30 basis points. Higher rates reflect that Donald Trump’s proposed tax cuts and fiscal spending plans are inflationary and could swell the national debt, raising the risk of default. Growing debt would require more bond issuance, meaning inflationary pressures could easily take hold; both would keep the pressure on bond prices. In short, we could see the return of the bond vigilantes.
Higher rates are pushing the dollar up, while Donald Trump’s endorsement of anti-trade policies has caused emerging market currencies to plummet. Stock markets, which have rallied, seem more preoccupied with Trump’s pro-business, anti-regulation narrative. Among other things, he has vowed to dismantle Dodd-Frank, amend, repeal or replace Obamacare, approve more pipelines and ease environmental regulations. As a result, financials, pharmaceuticals, mining, and energy stocks have seen notable gains in the days since the election.
Fiscal policy – Short term vs. long term effects
Equity markets focus on future earnings. So, the current upbeat mood in the stock market makes sense, even if it was a bit unexpected. More stimulative fiscal policy and fewer business regulations seem sure to boost near-term profits and economic growth. With fewer environmental rules, the energy industry will be encouraged to reverse some of their capital project cutbacks.
Meanwhile, the Congressional Budget Office (CBO) estimates a repeal of the Obamacare (ACA) would boost economic growth by 0.7 percent in the next decade. Lower corporate taxes should help make the US more competitive internationally, and more infrastructure spending should boost growth in the near term and productivity longer term. A profit repatriation holiday will encourage US businesses to bring more of their overseas dollars back to the US, potentially boosting capital spending as a result. And cuts to individual income taxes should boost consumer spending. All this should juice economic growth in the near term.
The end of globalisation?
Global trade will continue even without full US participation. Other countries will see this as an opportunity and step into the void, most notably China. Already, China is reaching out to former TPP nations in South East Asia for support of its Regional Comprehensive Economic Partnership, what it’s calling a “Beijing-led Asia Pacific FTA”. Add this to its recently launched Asian Infrastructure Investment Bank (AIIB), its One Belt One Road initiative, and the addition of the yuan to the IMF’s SDR basket of currencies, and it’s clear China is taking a different approach to engaging with the world than the US.
China and the UK recently agreed to allow select Chinese financial firms to open offices in London, as the UK tries to secure its relevance as a global financial centre post-Brexit. In exchange, for China allows some British banks to underwrite yuan-denominated debt issued by Chinese investors to non-Chinese firms.
A potential US retreat, then, could disrupt the economic world order and rules of engagement which for decades has been shaped by US policy and interests. The US was the driving force behind many global institutions (IMF, Word Bank, NATO) and globalisation itself (beginning with the Marshall Plan). A new narrative of less global integration could make the global economy feel more like a zero-sum competition than a web of interlocking, shared mutual interests.
What we think
Initially, markets reacted similarly to Brexit. Even if they seem less volatile now, the uncertainty associated with the new US president is not likely to change.
A quarter of Luxembourg’s exports outside Europe go to the United States and 60% of imports from outside Europe come from the US. The Grand Duchy should, therefore, maintain good trade relations with the US, although the Transatlantic Trade Investment Partnership (TTIP) agreement in its current form is likely to be rejected.
Luxembourg’s data protection legislation would also be quite strict compared to other European countries, which could be an obstacle to the government’s ICT ambitions.