PrefBlog

Those hoping for higher global interest rates via expansionary fiscal policy may soon get their wish:

Donald Trump’s gracious victory speech did two things. It defused much of the negative impact of the shock; and it reminded everyone that the US would have a more expansionary fiscal policy under a Trump presidency than it would have done under a Clinton one. This latter point may take time to be reflected in the markets, and the negative tone on international trade will put pressure on emerging markets. But it is quite plausible that US shares will rise rather than fall over the next few weeks. The dollar should recover swiftly too.

The reason for this is the easing of fiscal policy. With a supportive Congress it should be possible for the new President to get his proposed cuts in both corporation tax and income tax into law next year. Big business did not support a Trump victory but it will benefit from it. Of course, recession fears remain, for this has been a long expansion and the economy is pushing towards full capacity, but US growth next year may surprise on the up side, not the down. Additional spending on infrastructure will take time to feed through – there is no such thing as a shovel-ready project – but such investment will inevitably add to growth in the medium-term.

It is hard, however, to see growth being fast enough to close the budget deficit. A looser fiscal policy will be countered by a tighter monetary one. There was great hostility in the Trump campaign towards the Federal Reserve and to its chair Janet Yellen. But the Fed is independent and it would be unwise of any new administration to pick a fight with it. Right now the markets estimate that the chances of another rise in interest rates in December have shrunk from a near-certainty to an even bet. But this election increases the intellectual case for higher rates. Once they have settled down the markets may come to accept that such rises are inevitable and welcome.

There’s good support for this view:

The Committee for a Responsible Budget said this has made it difficult to evaluate Mr. Trump’s proposals, but estimated they could add $5.3-trillion (U.S.) to the federal debt over 10 years.
…
The initial impact of Mr. Trump’s protectionist policies may not be all bad. Economist Barry Eichengreen argued earlier this year that while tariffs threaten to fan trade wars and geopolitical tensions, the initial impact would be to boost U.S. wages and inflation, something the Federal Reserve’s easy money policies have so far struggled to accomplish.

Mr. Zandi’s team at Moody’s Analytics estimates that fully implementing Mr. Trump’s trade and immigration proposals could drive up inflation, eventually triggering aggressive Fed rate hikes and a recession, a concern shared by some investors.

PerpetualDiscounts now yield 5.13%, equivalent to 6.67% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 3.9%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 275bp, a sharp narrowing from the 290bp reported on November 2.

This entry was posted on Wednesday, November 9th, 2016 at 10:07 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.