ECR Extra Update

6th November, 13:16

Revenge of the deplorables 

Earlier today in an update, we covered market reactions to Donald Trump's victory in the US election. In this political special, we cast the net wider and look at what impact the new American political constellation will have on several policy areas and its implications for various asset markets.

Until last night, we heard analysts on the BBC and CNN, among others, proclaim that they did not understand Trump's strategy of making ever more extreme statements instead of trying to seduce the doubting voter in the middle. We wrote weeks ago that Trump did not want to target that group of voters, but rather the people who already felt numbed by politics and had turned away from Washington with the feeling that it was one big mess. Those Americans were probably just sensitive to someone who so blatantly shows that he disregards all the norms, rules and customs that prevailed in politics and will shake things up rudely.

What was striking about the exit polls was that the most important issue for voters was not the economy but the threat to democracy. And seemingly, then, there are a lot of people among those Americans who see not Harris but Trump as the savior of democracy.

But savior of democracy or not, the question we need to ask ourselves is what Trump and a likely Republican-dominated Congress is going to mean for the economy and financial markets. At the moment of writing, the House is still up for grabs, but the prospects for the GOP are promising. So, for the remainder of this report we assume a Republican clean sweep.

1. Fiscal Policy 

With a unified Republican government, the U.S. fiscal policy under Trump will focus on expansive tax cuts, alongside increased government spending. With a clean sweep, Trump will likely be able to implement most of his plans. Also, because in the budgetary process there is a way to avoid the Senate’s 60-vote filibuster threshold that provides lawmakers the chance to pass legislation with a simple majority vote. However, bond markets could get nervous and have a disciplining effect on the next administration.

• Tax Cuts: Building on the 2017 Tax Cuts and Jobs Act, which lowered the corporate tax rate from 35% to 21%, Trump has proposed further reductions to as low as 15% for corporations, along with additional tax relief for individuals. This would increase disposable income for households and potentially boost corporate earnings, fueling economic growth in the short term. However, such cuts, especially if not offset by spending reductions, could widen the fiscal deficit considerably. According to the Committee for a Responsible Federal Budget, Trump's proposals could add $7.75 trillion to the national debt by 2035.
• Increased Government Spending: Trump's potential focus on defense and infrastructure projects would require substantial federal spending, adding to the deficit. Infrastructure investment, while beneficial for long-term growth, requires significant outlays that contribute to the federal debt in the short term.

Market Implications:

• Interest Rates and Bonds: Higher deficits typically lead to greater borrowing by the government, raising the supply of Treasury bonds and potentially driving yields upward. The increase in government debt could push long-term interest rates higher, influencing borrowing costs for corporations and consumers. Higher yields may also indicate elevated risks associated with fiscal instability, prompting caution among investors.
• Equities: Reduced tax burdens could increase after-tax corporate earnings, especially benefiting sectors such as technology and finance, potentially pushing stock prices higher. However, some analysts, like those from Morgan Stanley, caution that the positives could be partially offset by deficit-driven inflationary concerns and potential monetary tightening. Companies with significant foreign exposure might also face headwinds from trade tensions and tariffs (discussed further below), which could dampen the equity market’s overall performance.
• FX Markets: Fiscal expansion and larger deficits may weaken the dollar due to concerns about the U.S. fiscal health. However, higher interest rates might attract foreign capital seeking higher yields, potentially supporting the dollar in the short term. The dollar's movement will thus depend on the balance between these fiscal concerns and yield-seeking capital inflows.

2. Trade Policy 

Trump’s trade policy, marked by protectionist tendencies, is expected to bring substantial changes, with particular emphasis on tariffs and restructured trade agreements.

• Tariffs: A 10% baseline tariff on all imported goods, and a targeted 60% tariff on goods from China, are among Trump’s suggested policies. These tariffs aim to reduce trade deficits and encourage domestic production. However, retaliatory measures from trading partners could ignite a trade war, increasing prices for both consumers and producers. We do expect the new administration to implement higher tariffs, but in this case candidate Trump’s bark is probably a bit worse than President Trump’s bite will be.
• Reshoring Initiatives: Trump has expressed a desire to bring manufacturing jobs back to the U.S. by imposing tariffs and incentivizing companies to move production domestically. The Peterson Institute, among others, warns that these reshoring efforts could lead to supply chain disruptions, increasing costs for U.S.-based companies reliant on global supply chains, particularly in sectors like technology and automotive.

Market Implications:

• Equities: Companies reliant on imports, especially from China, would face higher input costs due to tariffs, reducing profit margins. This may hurt industries such as retail, consumer electronics, and automotive. However, sectors with limited foreign competition or those that benefit from reshoring incentives might see a boost in their domestic market share.
• FX Markets: Protectionist trade policies generally reduce the demand for foreign goods, potentially leading to a stronger dollar as import volumes decrease. However, the dollar’s long-term direction would depend on the overall impact of tariffs on economic growth. Prolonged trade tensions might hinder growth, ultimately weakening the dollar as investors seek stability elsewhere.
• Commodities: Trade disruptions could affect commodity prices due to supply chain bottlenecks. For example, tariffs on Chinese goods might restrict access to critical materials, increasing costs across various commodities, which could lead to commodity price volatility.

3. Monetary Policy

Although the Federal Reserve operates independently, fiscal policies under a unified Republican government may indirectly influence its monetary stance. Expansionary fiscal policies and potential inflationary pressures could lead to adjustments in monetary policy.

With increased consumer spending from tax cuts and higher government expenditure, inflation might rise. As demand accelerates, inflationary pressures could emerge, particularly if tariffs increase prices for imported goods. Economists from the University of Chicago have warned that inflation could rise by an estimated 1–1.5 percentage points under such policies, depending on the scale of fiscal expansion.

Market Implications:

• Interest Rates: The Federal Reserve may respond to rising inflation by raising interest rates. This tightening of monetary policy could increase borrowing costs for both businesses and consumers, potentially slowing economic growth. Higher interest rates would also affect mortgage rates, impacting the real estate sector and potentially cooling the housing market.
• Bonds: Investors may demand additional yields to counter inflation risks, particularly in long-term Treasury securities, exacerbating the bond market's volatility.
• Equities: Higher interest rates make borrowing more expensive, potentially reducing corporate profitability. Certain sectors like utilities and real estate, which are sensitive to interest rate hikes due to high debt levels, could see stock price declines. Growth stocks, particularly in technology, may also underperform relative to other sectors due to higher discount rates on future earnings. 

4. Regulatory Policies 

The new Trump administration is expected to pursue deregulation aggressively, particularly within the energy, financial, and healthcare sectors. In this area, Trump will have lots of leeway, so expect plenty of initiatives. 

• Energy Sector: Trump’s agenda would likely focus on expanding fossil fuel production by rolling back environmental regulations, with less emphasis on renewable energy. According to analysts at the American Enterprise Institute and other think tanks, rolling back regulations will significantly lower compliance costs, boosting short-term profitability in oil, natural gas, and coal sectors.
• Financial Sector: Trump has previously advocated for reduced oversight of the financial industry, arguing that deregulation spurs economic growth. Potential regulatory rollbacks in banking could lower costs for financial institutions, though some argue it could also increase systemic risks.

Market Implications:

• Oil Markets: Deregulation might lead to increased U.S. oil production, contributing to an oversupply that could lower oil prices. However, global factors such as OPEC decisions and geopolitical tensions also play a role in oil prices, making the outcome less certain. For example, OPEC+ recently decided to delay a planned December oil output increase by one month.
• Equities: Reduced regulations in sectors such as energy and finance could drive up stock prices, as companies benefit from lower compliance costs. However, long-term environmental and social risks might create challenges, potentially affecting investor sentiment in ESG-focused funds.
• Gold: Greater uncertainty about the regulatory environment, along with inflation concerns, might boost demand for gold as a hedge against economic uncertainty and inflation.

5. Immigration Policies 

Trump’s immigration policies are expected to be highly restrictive, including measures such as mass deportations and stricter border controls (although he has also stated otherwise at times). These policies could impact labour markets and broader economic dynamics. In an interview with The Washington Post, Trump attempted to present a less hawkish stance on immigration, but his record as president suggests otherwise, according to think tanks like the American Enterprise Institute.

• Labor Shortages: Restrictive immigration policies could lead to labor shortages in industries dependent on immigrant labor, such as agriculture, hospitality, and construction. Reduced labor supply could increase wages, affecting profit margins in these sectors.
• Inflationary Impact: Higher wages due to labor shortages could drive up production costs, contributing to inflationary pressures, especially in low-margin sectors like food and retail. Analysts from Goldman Sachs suggest that labor shortages could lead to a 0.5% increase in inflation if restrictive immigration policies are implemented.

Market Implications:

• Equities: Industries heavily reliant on low-cost immigrant labor might see reduced profitability due to increased labor costs. Sectors like agriculture and construction may be particularly vulnerable, potentially facing operational challenges and cost pressures.
• FX Markets: Restrictive immigration policies could dampen economic growth by reducing labor force participation. A weaker labor market might lower the dollar's attractiveness as an investment, potentially leading to a depreciation.

6. Geopolitical Policies 

Trump’s “America First” foreign policy stance is likely to impact international relations, especially with China and other key trading partners. Escalating tensions could influence market sentiment and investor behavior (in the next regular Global Political Analysis, we will take a closer look at the geopolitical implications of the election outcome).

Market Implications:

• Safe-Haven Assets: Heightened geopolitical tensions often drive investors towards safe-haven assets such as gold, U.S. Treasuries, and the Japanese yen. If Trump’s foreign policies lead to increased global instability, demand for these assets may rise. Gold, in particular, could see increased demand.
• Equities: Geopolitical tensions can inject volatility into equity markets, especially for companies with significant exposure to international markets. Export-heavy industries, such as technology and automotive, might face additional headwinds if foreign markets become less accessible or if tariffs are imposed.

Conclusion

A Trump victory in the 2024 election with a Republican-controlled Congress would likely lead to substantial shifts in fiscal, trade, regulatory, and immigration policies. The combined effects of the policies of Trump II on financial markets could be summarized as follows:

• Equities: Likely volatility with opportunities in domestically focused sectors and potential challenges for industries reliant on trade and immigrant labor.
• FX: Potentially mixed effects on the dollar, balancing fiscal concerns with yield-driven capital inflows.
• Bonds: Rising yields expected due to increased government borrowing and potential inflationary pressures.
• Interest Rates: Anticipated upward pressure as the Federal Reserve may counteract inflationary risks from fiscal expansion.
• Oil and Gold: Mixed signals for oil, while gold may benefit as a hedge against inflation and geopolitical uncertainty.

PS: ►WEBINAR: Insights from the US Election - Implications for Global Financial Markets, with Eddy Markus - Tuesday, 12th November - 12:00 CET. 

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Kind regards,