Get ready to rumble

America has spoken. President Trump will return to office after Christmas. He will be the first to return after a breather since Bourbon Democrat, Grover Cleveland in the late 19th Century. There will now be an unseemly (and mostly in/uncredible) stampede by the commentariat to tell us what this means for the years ahead. With the benefit of hindsight, we will be able to identify much, if not all, of it as wasted breath/ink.

The market reaction so far is most pronounced in the bond market. Interest rates across all maturities are sharply higher, with the dollar following suit. The intuition here is that many of the President’s policy proposals, if taken seriously and literally, point to both more inflation and less credibility for the Federal Reserve. Much will obviously depend on how this next administration is staffed.

The economy President Trump will inherit in January is currently motoring. Business dynamism is resurgent, productivity growth is already well above the trends that characterised the prior decade and most of the people who want work have it. Meanwhile the threat from inflation is receding, even if some might argue the psychological scars it inflicted on the populace are flecked throughout this election result.

The difficulty for investors in amongst all this is not just understanding what of the President’s campaign trail talk makes it into policy, but how will other protagonists react. We look at a couple of those below as illustration.

China?

China’s muscular rise this last few decades has stamped on a lot of toes in the international trading sphere. The so called ‘China shock’ has evolved in multiple stages (and guises) over that period as China’s export mix has evolved. The first shock reverberated around the world’s manufacturing hubs, as the Middle Kingdom shifted from consumption goods to capital goods around the turn of the millennium.

The next shock can be traced back to the year of the pandemic and has been characterised by a mixture of factors. The fastest growing products in terms of export share sit in electronics, technology goods and electric vehicles. However, these may not be the areas that pose the greatest disruptive threat to domestic industries in competitor countries. The combination of a sharp shift in Chinese domestic demand away from Internal Combustion Engines (ICE) and the slump in property leaves them nursing intimidating surpluses of both cars and construction equipment. It is not the US that necessarily has the most to fear here, more Europe (in particular Germany) and Japan, where export baskets look eerily similar.

Chinese authorities have plenty on their plate in any case. The domestic economy is deeply troubled with the residential property bust continuing to dominate the scene. Policy makers have so far announced a patch work of measures and some large numbers have been unofficially bandied.

However, the question for the moment is whether the return of President Trump will increase the urgency of China’s policy makers? Domestic demand takes on greater significance with the global trading environment potentially set to take on an even more carnivorous bent. Long resisted reforms to the social safety net among other areas tangentially associated with household confidence could become more appealing in such a context.

Europe?

Europe has long been in the returning President’s sights. The EU remains a “union of nationally organised democracies that is reliant on an outside power for external security…” (Helen Thompson, Disorder). To that extent, the construction of Europe’s still unfinished fiscal and political architecture has always seemed to respond more readily to stick rather than carrot.

Crises can be helpful, as the leaps forward taken in depths of the euro crisis and more recently in the pandemic and the Ukraine war suggest. Perhaps a less friendly US administration helps shunt the EU towards combined debt issuance, a key strut in Alexander Hamilton’s efforts to build the United States post-revolutionary war. Other important reforms (capital markets union) and programmes may also be moved up the agenda by a more adversarial relationship with the US.

Markets?

Much of the period following the Great Financial Crisis of 2007 – 09 saw markets in mostly permissive mood. With inflation largely absent and central banks therefore able to liberally sedate bond markets with escalating quantitative easing programmes. As a result, policy makers had a freer rein than seen for much of the past.

Neither of those background conditions are true of the moment. As Prime Minister Truss’ brief time at the top demonstrated, bond investors are no longer in such forgiving mood. The inflation shock may be passing, but it is fresh in the memory. As usual forecasters are now responding by suggesting more of the same should be expected in the path ahead. In fairness, it is certainly conceivable that the necessary green transition comes with more kinks in the supply/demand balance of the relevant commodities.

As noted above, we are already seeing bond investors grapple with some of the potential policy shifts we would see in the years ahead in today’s markets. Some of these, particularly those requiring congressional passage, will take longer to take effect. However, central bank interference and trade measures, particularly if enacted via the temporary framework available to the President, can take effect quicker.

The question posed on this area surrounds the feedback effects on policy makers. As we saw in the Truss administration’s brief battle with markets, the bond market can have significant influence. The same could conceivably be true of the incoming Trump administration.

Is it conceivable that the bond market could remain relatively placid in the face of escalating fiscal deficits and rising debt to GDP without limit? The ‘exorbitant privilege’ famously enjoyed by the US is already being milked hard by the current administration. We can add to this a US corporate sector already generating record levels of profitability and enjoying premium valuations as a result.

Investment conclusion

Interesting times lie ahead. In amongst the distraction and noise, the most important thing for investors to keep an eye remains the trends in productivity growth. There are things that the incoming administration can do to blunt these trends, universal tariffs would certainly pose some threat. We will need to keep a close eye on how the administration is populated. On top of this, the degree of congressional clout enjoyed by President Trump is still to be decided, with the House vote still undecided at the time of writing.

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