The ingredients of the Trump economic cocktail

Posted on November 19, 2016

Somehow, a lot of investors are expecting President Trump to be the economic love child of Lawrence Summers and Ronald Reagan. If implemented, a combination of pro-business tax and regulation policies and increased defence and infrastructure spending could certainly be a bullish cocktail for investors in the short term. But those buying into the euphoria should be careful to read the small print.

Investors are buying US stocks — especially bank stocks — on the assumption that Donald Trump is going reflate the economy in a way that will benefit Wall Street more than most. That looks like a good bet, given the emphasis among his close advisers on unpicking post-crisis bank regulations, cutting taxes and pushing up interest rates. All of those things will make it easier for banks to make money. Selling bonds to buy equities is also likely to be a profitable strategy, at a time when the US was already looking at the prospect of rising inflation and looser fiscal policy, long before November 8.

But now for that small print.

First, although Mr Trump is likely to preside over a shift from monetary to fiscal support for the economy, not all fiscal expansions were created equal.

Eight years into a slow recovery marked by stubbornly low productivity and weak private investment, increased public spending to support long-term potential growth could indeed be a win-win for the US and other developed economies. But even if Congress lets the new president have his way on the budget, his focus has tended to be on tax cuts for businesses and public-private partnerships to boost infrastructure spending.

Mr Trump has not talked about investment in skills and education, for example, which businesses — especially small ones — frequently cite as the greatest barrier to faster US growth. As Mr Summers himself has pointed out, public-private approaches to infrastructure investment are going to leave a lot of high priority projects out.

There is a huge amount we don’t know about the president-elect’s plans but, overall, the kind of policies he’s suggested spending money on are not those that economists would say are likely to give the highest economic return.

If that’s right, any short-term boost to growth will come with a shortening of the economic cycle, rather than an increase in US potential growth, and thus bring the date of the next recession closer. The message for investors in US equities is: enjoy it while you can, and mind the gap between expectations and reality.

So the small print for the rest of the world from this post-Trump rally is that policymakers do not have a lot of time left to reflate their own economies before the global cycle turns negative and the challenges become that much greater.

Some would argue that rising US inflation and interest rates will make it easier for the eurozone countries to recover, by giving European policymakers more room to import inflation via a weaker currency. But the rout in the global bond market means that financial market conditions have tightened sharply since last week — at a time when core inflation shows very little sign of rising above 1 per cent.

Slowly but surely, fiscal policy had been playing a more supportive role in the eurozone, just as many economists have long suggested. But that increased government spending has been indirectly bankrolled by the European Central Bank through the dramatic fall in the cost of servicing long-term government debt.

The risk for the bloc in this new environment of rising global real interest rates is that looser fiscal policy becomes both more necessary and a lot more expensive. That make it even more important for European policymakers to embrace the right kind of structural reforms — and the right kind of investments in long-term growth. Europe needs those things a lot more than the US does.

The final piece of small print is also the most obvious: buy into this Trump rally if you want to, but be warned that a further period of Wall Street doing better than Main Street is not going to silence the populist forces that got Mr Trump elected. A global economy that does not deliver for a large proportion of its citizens is ultimately not going to deliver for investors either.

Stephanie Flanders is chief market strategist for Europe at JPMorgan Asset Management

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