Forces Of Movement

The results of the US election did not unleash new forces in the capital markets as much as accelerate those forces that we had already identified as being operative.  The cyclical low in interest rates has likely already been registered. There also seems to be a somewhat  greater willingness in several countries to move toward looser fiscal policy. The divergence between the US monetary policy on the one hand, and the EU and Japan on the other, is poised to widen further. 

It is not unusual that, despite the fiercely fought partisanship, the US political cycle does not exactly coincide with the economic cycle.  For example, the deregulation and military build-up that is associated with Reagan began under Carter. Following the Soviet invasion of Afghanistan, Carter began boosting military spending, and the deregulation of the airlines began on his watch. Although we dub the dollar’s bull market of that era as the “Reagan dollar rally,” it began before he was elected. Volcker had already begun hiking interest rates, and the dollar had bottomed.   

The recognition of the limits of monetary policy had become several commonplace quarters ago. A new Canadian government provided modest fiscal stimulus. Hammond, the UK Chancellor of the Exchequer, is expected to also offer some stimulus in his Autumn Statement later this month.  

At the same time, Fed officials have been signaling their growing comfort to raise rates again. Nine of the 12 regional Presidents called for a discount rate increase. Economists argue that headline inflation converges to core inflation, and core inflation regresses to labor costs.  Hourly earnings rose 2.8% in the year through October, the most in seven years. More broadly, deflationary pressures outside of Japan have eased in recent months.  

There is much uncertainty about the policies of a Trump Administration. Within days of the election, Trump seemed to back away from completely scrapping the Affordable Care Act (Obamacare), firing Fed Chair Yellen, getting rid of the entire Dodd-Frank omnibus financial regulation bill, and pursuing legal charges against Clinton.  

However, there has been no sign of wavering about the commitment to a strong fiscal stimulus package. An economic adviser to Trump penned an op-ed piece in the Financial Times before the weekend that sketched out the $1 trillion stimuli in the form of tax cuts and infrastructure spending. With a roughly $18 trillion economy, the stimulus is significant at 5.5% of GDP. In terms of GDP, that is, incidentally, the same size as the February 2009 stimulus package tax cut and spending package).

The stimulus would reach a US economy that is already growing near trend. Trend growth is the sustainable pace consistent with stable prices.  The Federal Reserve has surely but slowly cut its assessment of this pace to 1.8%. An unscientific sampling of private sector economists puts at 1.5%-2.0%. Stimulus on top of trend growth is understood to be inflationary. This implies a somewhat stronger monetary response and the derivatives market appears has begun the discounting process. For example, the implied yield of the December 2017 Eurodollar futures contract rose nearly 25 bp since before the election.