The Trump Trade Looks Overblown
Donald Trump’s great stimulus flatpack is unlikely to be as great as the promised say analysts at Capital Economics, but the Dollar will continue strengthening regardless.
A great spending boom and period of global reflation is upon us, or at least that is what we have been led to believe since Donald Trump's victory in the US presidential elections.
Global inflation expectations of shot higher and investors have dumped bonds in response, driving up the Dollar to its highest levels in 14 years.
Trump’s policies aimed at stimulating the economy via a boost to infrastructure spending and tax cuts are likely to add 0.7% of growth to the US economy in 2017, according to Capital Economics’ Julian Jessop.
“The prospect of a major fiscal stimulus means that we are raising our forecasts for US growth, inflation and interest rates next year. There is still considerable uncertainty surrounding exactly what fiscal, trade and regulatory policies President-elect Donald Trump will pursue in office, but we now expect GDP growth to be 2.7% in 2017, compared with a pre-election forecast of 2.0%,” says Jessop.
We have seen a major jump in US inflation expectations since Trump's victory earlier in the month as global markets price in the extra spending promised by the president-elect.
This has in turn pushed US treasury yields higher which has in turn boosted the Dollar in what has become known as the Trump Trade.
On the face of it this should be positive for riskier assets such as equities, says Jessop, but in reality inflation’s ills – higher wages and raw materials – will erode the profitability of stimulus for business, reducing upside traction in the stock market.
Capital Economics see US inflation rapidly ascending to 3.0% by the end of 2017, in fact, a steep rise by anyone’s account.
“We now expect both headline and core CPI inflation to climb above 3% by end-2017,” notes Jessop.
In such an environment the Federal Reserve will be forced to take action to cool the economy by raising interest rates, with an expected end of 2017 range of between 1.5-1.75%.
“We have factored in additional increases to between 2.5% and 2.75% by end-2018 – well above what appears to be priced into the markets and reflected in analyst surveys,” added Jessop.
If rates do ‘take off’ in this way then the Dollar will also be propelled higher too as investors seek higher yield in the US.
The monetary policy trajectory in the US, set by the Fed, is likely to diverge sharply from that in the UK, say Capital.
“The main impact of the “Trump stimulus” would, therefore, be to reinforce the contrast in monetary policy between the US and elsewhere.
“We think that monetary policy in the UK and Japan is set to remain very accommodative and that the ECB is likely to extend its asset purchases.
“This contrast should put further upward pressure on the US dollar, which we expect to strengthen to 120 against the Japanese yen and parity against the euro in 2017.
Capital Economics see limited scope for upside in US equities due to the strong dollar and inflationary costs.
Equities in the Eurozone or Japan, on the other hand, are likely to fair better on the back of limited cost inflation and a cheaper exchange rate.
The great infrastructure spending push is unlikely to be as big as the 500bn promised as the majority of the ‘stimulus’ will probably come from tax cuts to wealthy individuals and businesses.
“The bulk of the stimulus will come in the form of tax cuts for high income earners and lower corporate tax rates.
“In contrast, the infrastructure spending boost will probably turn out to be much smaller than the estimates of $500bn to $1trn currently being thrown around,” said Jessop.
This, in turn, will not give commodities such as industrial metals the boost they need.
Corporate Repatriations Might Not Boost US Productivity
One of the most popular ways to fund the infrastructure stimulus plan is to use repatriated money earned or stashed by corporates abroad.
Trump has suggested a one-off extremely low tax rate of 10% on money repatriated by Businesses from abroad.
“Admittedly, the amounts involved are not trivial.
“We estimate that US firms held approximately $2.5trn of earnings overseas in 2015. (See our US Economics Update, “Firms continue to hoard cash overseas”, 19th September.)
“While a chunk of this is tied up in physical plant and machinery, much of it is held in liquid form and could, therefore, be brought back home with relative ease,” says Capital Economics' John Higgins.
Yet Higgins is skeptical that the repatriated money will be put to work in the way intended.
Most of the money is held by a relatively small number of big corporates who already have domestic surpluses which they don’t choose to invest in the economy, so how can be assumed they will invest repatriated funds?
“If they wanted to invest heavily in the US economy, they could do so already without needing to bring money back from abroad.
“Repatriated funds are therefore more likely to be used for other means, such as buying back shares, than to boost the economy’s growth (and companies’ future earnings) potential,” said Higgins.
Higgins points out that this might help fuel further gains in the stock market as the increased demand will boost the share price.
Companies with surpluses spending those surpluses on buying back their own shares will push up the price of the shares in a feedback loop, which is likely to be boosted by repatriations.
This is likely to offset losses caused by higher inflation increasing costs and squeezing margins, as highlighted by Capital’s Julian Jessop.
