USA
• Trumponomics 101
• Fed implications
Last Wednesday, on day one after the US presidential election, the U.S. dollar gained 0.8 % versus the Euro, the Dow Jones was up by 1.4 % and 10-year US treasury yields rose by 20 basis points above 2 % for the first time since mid of last year. Compared to another major unexpected voting outcome – the UK referendum in June, the market reaction was contrary: On 24th June, the British pound was massively down, UK equities fell and bond yields had corrected.
Trumponomics: Financial markets like it.
Why so? Trump wants to create a “dynamic booming economy” increasing annual GDP growth by 1.5 % (to 3.5 %) and resulting in 25 million new jobs over the next decade. Policies include a major tax reform, a new regulatory framework, an America-first trade policy and an unleashed American energy plan (free the United States of dependence on foreign oil). The tax plan aims to reduce taxes across-the-board. With respect to individual income tax, it will collapse the current seven tax brackets to three brackets (less than 75,000 USD: 12 %, more than 75.000 USD but less than 225,000 USD: 25 % and more than 225,000 USD: 33 %). The standard deduction is expanded from 12,600 USD per couple to 30,000 USD. The tax plan includes a large reduction in the business tax rate from 35 % to 15 %. It will provide a deemed repatriation of corporate profits held offshore at a one-time tax rate of 10 %. Presumably, the tax reduction plan puts the largest burden on the federal budget. It is planned to repeal the Affordable Care Act (ACA or “Obamacare). Obamacare roughly decreased the percentage rate of U.S. adults without basic health insurance from 18 % in 2014 to 11.4 % in 2015. Alternatively, the introduction of a tax-free Healthcare Savings Account (HCA) is envisaged. On the expenditure side, a major infrastructure investment program was promoted during the campaign. Interestingly, infrastructure investments have been circulated in the last couple of years for example by high-profile economist Larry Summers (to avoid ‘secular stagnation’), a democrat who served as Treasury Secretary under President Clinton. Furthermore, Trump proposed repealing the budget sequester (setting automatic limits to discretionary federal spending) and to increase military spending. He proposed to increase the number of active army troops from 475,000 to 540,000, the number of marine battalions from 24 to 36, the number navy ships from a planned 280 to 350, and the number air force fighter aircraft to at least 1,200. On the other side, the “penny plan” is aimed to reduce non-defense spending by 1 % per year.
Putting the numbers together, Trump’s economic program implies a major fiscal boost for the U. S. economy. The 10-year increase in the federal deficit is estimated at 5.3 trillion USD or roughly additional 2-3 % of GDP per year (calculated under simplified assumptions). Over the same period, U.S. federal debt would increase to 105 % of GDP from around 77 % in 2016, while debt would have reached 86 % of GDP within a decade by extrapolating current policies.
It will be seen which plans will eventually be realized, but there is a high chance that some proposals get through the legislative process, since the new president faces a Republican majority in the congress over the next two years.
What does the new presidency imply for the Fed?
Certainly, there is more uncertainty now with respect to the course of monetary policy. Given solid growth data (Q3 GDP expanding by 2.9 % q/q, annualized rate) and solid labor market data (October employment report) as well as the preparatory statement by the FOMC in October, we would keep expecting the Fed to hike the target range of the federal funds rate by 25 basis points to between 0,50 % and 0,75 %. Higher growth – induced by fiscal stimulus – will spur inflation, given that the U. S. economy has been running near its potential and unemployment has converged towards its natural level. Higher inflation leads to higher interest rates. In addition, restrictive trade policies – including higher tariffs for products from abroad, would increase import prices and further pull inflation. President Yellen’s term is going to end in January 2018, so Trump could replace her in late 2017 by another candidate given reportedly critical comments on Janet Yellen and the Federal Reserve. It will be interesting to see whether political pressure on the central bank is set to rise.