Given President-elect Donald J. Trump’s lack of political track record—and considering the absence of detail about his intended policies, apart from general campaign promises—we find it difficult to ascertain what the upcoming Trump administration will do, and in what order of priority.
For the time being, we believe this cloud of uncertainty about policy may affect markets and trigger periodic volatility until we gain a clearer picture of the new administration’s plan—which could happen only well into 2017.
The Trump Administration’s Agenda Is a Wildcard
From a historical perspective, we know little about the politics of the current president-elect, who is an outsider to the political arena and, in many respects, a third-party candidate who happened to get a major party’s nomination.
In the late 1970s, President Jimmy Carter attempted to pursue most of his agenda early in his administration with little success through Congress. A few years later, Ronald Reagan followed a more laser-focused plan, fulfilling his agenda one item at a time. Bill Clinton tried to enact his most controversial policies first—to his detriment—whereas Barack Obama opted to focus immediately on only one area (the fiscal stimulus of 2009) and relegated the other two (financial-services reform and healthcare) to a later stage.
What are the specifics of Mr. Trump’s agenda—and how does he intend to enact them? It’s not clear—nor can anyone realistically predict how his plans might be received in Congress. Yet we do know from past elections that tensions between the president and the legislative branch tend to begin almost immediately.
The Implications of a Trump Administration for Global Fixed Income
Though nothing is certain on the basis of what we know, we’ll attempt to outline what we believe are the most likely primary implications of Mr. Trump’s victory for investors in global fixed-income assets and currencies:
- Volatility among developed-market government bonds are expected to be higher in the foreseeable future.
- The U.S. dollar should broadly strengthen over the next several months.
- Mexico’s economy may underperform relative to recent quarters.
- Punitive trade measures could challenge Chinese economic growth, should Mr. Trump decide to enact them.
- The European Central Bank (ECB) may have the impetus to extend its bond-buying program, and the Eurozone faces a mixture of potential risks and rewards from the new U.S. administration.
Let’s cover each of these items in detail.
Interest Rate Volatility Is on the Rise
The move up in yields since the election has been driven primarily by an increase in inflation expectations rather than credit risk. While the move began well before Election Day, the yield move did trend in concert with Mr. Trump’s standing in the polls and accelerated after his election. Markets seem to be suggesting that they expect fiscal stimulus that could benefit growth and increase inflation expectations.
Although there had been some dramatic moves in U.S., European and Japanese interest rates over the course of the year, generally these moves were within relatively well-defined ranges until very recently. For example, this year, German 10-year bond yields trended between 0.25% down to -0.20% from February through November 9th. There were days when yields moved 0.10% or more within that time frame, but the range was very well-defined.
Now that markets are anticipating stimulative fiscal policies in the U.S., inflation expectations globally have been increasing and causing bond yields to follow. Although future monetary policy remains to be seen—as does the future composition of the Federal Reserve Board of Governors and its chair—the market is assuming the next chair will be generally dovish on inflation.
Higher rate volatility is neither a good or bad outcome for the economic environment, but it does suggest that central banks may have less control over longer-term yields than they enjoyed over the past several years, since bond-buying (i.e., quantitative-easing, or QE) programs were introduced. In the case of Japan, it is likely that yield targeting and QE will continue to be effective at home, and it’s the Japanese currency that will likely have to adjust should U.S. economic activity and yields increase meaningfully over the next several years.
Our global debt team has recently shunned negatively yielding assets as we are concerned about volatility similar to what we’ve experienced the last few days. The risk/reward profile of government bonds with negative or near zero yields remains particularly skewed to the downside as growth and inflation remain positive yet subdued.
The U.S. Dollar Is Strengthening
We believe that over the next several quarters, it is likely that the U.S. dollar will strengthen because of a prospective interest-rate hike by the Federal Reserve Bank (the Fed), and the effect of fear over protectionist trade policies.
- Rate hikes: We believe that the Fed is likely to hike rates in December. And as expectations for fiscal stimulus increase during Mr. Trump’s honeymoon period, so could expectations for U.S. economic growth relative to its many trading partners. In such periods, the U.S. dollar generally does well. A rise in the U.S. dollar may not persist far beyond the enactment of fiscal stimulus, but we continue to own only a select basket of currencies—and will remain underweight in our exposure to foreign exchange for now.
- Fear of protectionist trade policies: Should the Trump administration threaten to raise tariffs (he would have to do so selectively, as there are many trade-related laws that he would need Congress to overturn), the U.S. dollar would likely strengthen as well. It is much more likely that Mr. Trump would cancel unapproved trade deals and begin negotiations to amend portions of existing agreements such as NAFTA, which may require amending U.S. laws.
Mexico Is the Special Case
Mexico’s response to the election result was swift. The central bank and finance ministry held a joint press conference on November 9th to reassure investors that they are vigilant with respect to market conditions.
The Mexican peso weakened sharply against the U.S. dollar—from a low of 18.2 pesos to the U.S. dollar when the prospects of a Clinton presidency seemed greater, to more than 20 as momentum shifted toward Mr. Trump. Mexican government authorities stressed the strength of the country’s macroeconomic framework and progress made on the track to meet the country’s budget deficit this year. Yet they stopped short of indicating any intention to directly intervene in the currency market or take any unplanned monetary policy action.
While Mexico’s central bank waits to see if markets stabilize, it is likely that it will choose to hike rates this year—perhaps as soon as this week’s scheduled meeting on November 17th—to support the peso and local bond market.
Moreover, Mexico’s finance ministry aims to attain a primary budget surplus in 2017. Should the balance fall short of the target, the Mexican government is committed to adjust spending as needed in order to attain their target. To the extent that Mexico produces a credible path of government spending that is consistent with its target, rating agencies may refrain from taking more immediate action on their negative outlooks for Mexico.
But the larger impact from Mr. Trump’s election may be on Mexico’s growth prospects. There are close linkages between the Mexican and U.S. economies: The United States absorbs 80% of Mexican exports and generates 40% of inward foreign investment. New policies enacted by the Trump administration toward Mexico (such as in trade or immigration) may cause affected companies to revise their business plans, which would take a toll on Mexico’s economic performance. Without the support of a recovery in Mexican exports in 2017—and if business and consumer confidence in Mexico sustain a blow— the forecast for Mexico’s Gross Domestic Product (GDP) growth may be revised further downward relative to what it was before Mr. Trump’s election.
So far, fiscal consolidation (i.e., tightening) is seen as a risk to Mexico’s growth prospects in 2017. But now, the risk of new trade policies by the Trump administration poses an additional threat.
Finally, while it is still too early to draw political parallels at this stage, Mexico’s presidential election in 2018 will be taking cues from political developments in the U.S., where populist, anti-establishment political candidates may feel empowered—and win the vote.
China May Be the Easiest Target for an Anti-Globalization Stance
Mr. Trump promised to declare China a currency manipulator on his first day in office. Under the existing Treasury framework, labeling China as a currency manipulator may not be so easy. Yet it’s likely that the Trump administration will change this framework later on during its term. What would a “currency manipulator” label mean?
Such a label would likely not be too onerous on the Chinese economy. After all, China was already labeled a currency manipulator from 1992-1994—and the label per se did not have much impact.
However, labeling a country as a currency manipulator also opens the door to renegotiating existing trade deals between the two countries, which could have more far-reaching implications.
A more significant threat is imposition of punitive tariffs on Chinese imports. Under the World Trade Organization (WTO) safeguards agreement, the president could impose temporary tariffs on some Chinese products, but the nonpartisan International Trade Commission would have to certify that subsidies on these products, or dumping, have materially harmed the affected domestic industries. Besides these measures, the private sector can apply for countervailing duties against dumping or illegal subsidies for specific products. It is conceivable that these measures would be more actively taken.
Considering that Chinese imports make up about 50% of the U.S. current account deficit (compared with about 9 % for Mexico), temporary tariffs or product-specific countervailing duties are not likely be broad-based enough to make a permanent dent in the bilateral trade deficit, though they would add substantially to the ongoing weakness in Chinese exports and have a spillover effect on broader trade.
Although the U.S. president has the power to levy tariffs across the board in response to a national emergency, the WTO is likely to mount a challenge against such tariffs.
Any tariffs outside the WTO framework would probably trigger counter-tariffs from China, which could spiral into an open trade war. The impact from punitive trade restrictions would create an additional drag on economic growth in China and also other North Asian countries such as South Korea and Taiwan, as well as other countries linked to global supply chains. One should also not underestimate the inflationary impact of such restrictions on the prices of goods in the U.S. The effect on the Chinese yuan would also be negative and push the Chinese authorities to tolerate more currency weakness than they otherwise would.
Should U.S. trade policy lead to a material impact on Chinese growth, the Chinese government is likely to respond with more fiscal stimulus and possibly slow the pace of structural reforms in order to stabilize growth. This development would be positive for growth in the short run, but it would also increase the risk of a hard landing later on as the fiscal stimulus fades.
Beside trade, a more inward-looking, isolationist U.S. foreign policy (both diplomatic and military) could create room for China to expand its sphere of influence in the Asia-Pacific region and Africa.
Will Europe Extend Its Bond-Buying Program?
The new U.S. political regime, with all of its uncertainty for the world, makes a stronger case for the ECB to extend its bond-buying (or quantitative easing) program at its December meeting, as we expect.
The result of the U.S. election—much like Brexit—is making experts question the accuracy and validity of political polling, and it adds to the sense that future European elections may also have unexpected and surprising results. This may lead to an elevation in the perceived risks surrounding Europe’s political calendar, including the Italian referendum in December. Even if baseline risks remain the same, the risk premia around them should be higher, and markets therefore should be volatile as they price in such uncertainty. In Europe, such risk pricing could translate into higher rates among bonds in peripheral countries, although these rates could be offset by more aggressive monetary policies by the ECB.
Also unclear at this stage is the Trump administration’s policies regarding the North Atlantic Treaty Organization (or NATO), established to counter the Warsaw Pact led by the former Soviet Union. Mr. Trump mentioned having European countries “sharing the [financial] burden” of enjoying the protective presence of U.S. forces on their soil and other defensive measures. If he follows through on his demand, European nations may find themselves having to increase military spending—a de facto fiscal-stimulus program.
The U.S. is a major market for European exports, but so are emerging markets. And while the Eurozone was able to contain Brexit fairly well from an economic perspective, its economy would suffer from a slowdown in exports not only to the U.S.—but also to emerging markets (if, for example, China’s economy were to soften as a result of Trump administration policies).
The General Outlook Is Unknown
As for general investor confidence and the possible effects of financial contagion, we will have to wait and see how events play out. One risk is that investors would be increasingly nervous about political risks—even if the baseline is benign—and demand higher risk premiums. Such demand may hamper the economies of peripheral European economies and credit markets.
The repatriation of capital back to the Eurozone, on the other hand, can benefit core European markets, especially since Europe enjoys a capital surplus after all. Finally, as previously mentioned, these developments would make a stronger case for ECB to act in December and continue with its QE policy.
It is too early to identify the full implication of the unexpected election results, however, rhetoric suggesting a dramatic change in many policies seems unlikely. Congress, particularly the Senate, and the judicial system will likely moderate many, if not most, of Mr. Trump’s more grandiose plans. It will be enlightening to see how Mr. Trump reacts to stumbling blocks created by the U.S. Constitution and governmental process – such as the separation of powers. Concern and speculation are likely to remain rife, but as has occurred early in many past presidential administrations, much of the new regime’s agenda is likely to be more moderate than the campaign rhetoric leading up to the election.
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The mention of specific countries or securities does not constitute a recommendation by any Oppenheimer fund or by OppenheimerFunds.
Mutual funds are subject to market risk and volatility. Shares may gain or lose value.
Fixed income investing entails credit and interest rate risks. Interest rate risk is the risk that rising interest rates or an expectation of rising interest rates in the near future, will cause the values of a fund’s investments to decline. Risks associated with rising interest rates are heightened given that rates in the U.S. are at or near historic lows. When interest rates rise, bond prices generally fall, and a fund’s share prices can fall. Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes, regulatory and geopolitical risks. Eurozone investments may be subject to volatility and liquidity issues. Emerging and developing market investments may be especially volatile.
These views represent the opinions of OppenheimerFunds, Inc. and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the publication date, and are subject to change based on subsequent developments.