US: Politics will remain front of mind for investors - TDS

Research Team at TDS expects that the U.S. politics will remain front of mind for investors as the Trump administration gets underway in January.

Key Quotes

“Trump’s unexpected electoral victory opens a wide range of potential political, economic, and policy outcomes as matters progress from the rhetoric of the campaign trail to the reality of governing. Trump promised considerable infrastructure spending and tax cuts throughout his campaign, with some estimates upwards of $5tn in added deficits over the next decade. We believe that any eventual plan will be considerably smaller in its implementation, but there are upsides to the fiscal deficit as infrastructure spending and/or tax cuts are delivered.” 

“Treasury yields are expected to push higher as current (official) deficit expectations for fiscal 2017 may prove to be vastly underestimated. We now look for benchmark 10Y Treasury yields to rise to 2.75% by end-2017. We see much of the increase in yields materialising earlier in the year as investors increasingly anticipate widening deficits. We similarly expect the fiscal stimulus to boost inflation expectations, pushing TIPS breakevens wider. The greater risks for markets is then in the second half of the year as anticipation requires actual policy delivery. An important clarification here is that in recent years policy shocks have been disinflationary and/or anti-growth, and this pricing for 2017 is exactly the opposite.”

“While markets have shown a positive initial reaction to Trump’s pro-growth message, some of Trump’s campaign pledges and lack of experience have also roused some of the greatest concern within markets, particularly those related to trade protectionism and limits on immigration. On these issues, the U.S. President does have a fairly free hand to act if desired. If Trump imposes tariffs on certain imports, delivers on his promise to unwind NAFTA, or labels China as a currency manipulator, risk markets are likely to react negatively. Also, protectionism is also typically inflationary first for the protectionist, leaving scope for unusual relationships of TIPS to the US uncertainty shock and an attractive hedge.”

“The risks are not all to the downside. In addition to the tax and investment-led boost to growth of his fiscal plans, Trump’s deregulatory stance could also benefit financial markets. The swath of regulations has increased balance sheet costs in recent years. While rising deficits could continue to push swap spreads tighter (more negative), a rollback of the regulatory thrust could reduce the cost of balance sheet, allowing swap spreads to widen.”