Trump victory places downward pressure on risky assets

  • Downward pressure on risky assets could be seen in coming days until clarity emerges on Trump's policy agenda as market gauges the gap between his campaign rhetoric and potential policy reality
  • Tax cuts now probable with a Republican Congress will likely boost inflation and weigh on bond markets. This pressure can worsen if tariffs are imposed on foreign trading partners and existing trade deals are undermined (a topic Mr. Trump has discussed extensively during his campaign)
  • December interest rate hike could be off the table if equity market continue to trade negatively
  • US Dollar dynamics dependent on the exact policy path Mr. Trump takes

Mr. Trump is the 45th president-elect of the United States of America, in a result that has defied all pre-election predictions. Several commentators are calling it the biggest political upset in history, given the often bitter and scandal ridden campaign Mr. Trump has run. In the past, this would have torpedoed the presidential hopes of candidates. Not this time. History has been re-written as Republicans sweep the board across the ballot.

What are the investment implications – downward pressure on risk and US bonds
Given the controversial and divisive rhetoric exhibited by Mr. Trump during the campaign, we expect downward pressure on risky assets to continue in coming days, or until more clarity emerges on his policy agenda. Assuming the high likelihood of tax cuts at a time of full employment, the US Treasury curve will, in our opinion, steepen. The outlook for US equities can improve if immigration issues are not made a key policy focus under the Trump presidency. It is worth noting the equity market outlook is under the influence of opposing forces emanating from potential fiscal easing under a Mr. Trump presidency vs. strengthening of the anti-globalisation narrative of his campaign rhetoric. In the short-term, depending on the reaction of the equity market (if the damage is strong), the Federal Reserve could take the upcoming December interest rate hike off the table. Beyond that, we anticipate a hawkish Fed trajectory to accommodate fiscal easing.

The initial knee jerk reaction of the US Dollar has been a weakening trend against other advanced economy crosses. However, it is far from clear that the US Dollar will remain under a cloud under Trump, especially, if fiscal easing takes precedence over some of the more divisive campaign pledges made, thus necessitating a hawkish shift in monetary policy.

Trump policies – what do we know?
For Mr. Trump, trade and immigration have been key areas of focus during his campaign, where the executive branch has a freer hand in making policy. In the US, Congress has the sole power to distribute funds and discretion of the executive branch has reduced over the years.

From an immigration perspective, the executive branch has more discretionary power, which President Obama has also used to influence policy. Here, Mr. Trump’s campaign pledge to deport unauthorised immigrants is a realistic possibility – a policy direction which would need careful monitoring in coming days.

Trade is also an area of greater executive policy discretion. The US constitution states that Congress has a mandate to shape commerce with foreign nations, but over the years much control has been ceded to the executive branch. More importantly, Presidents generally have the authority to withdraw from bilateral and multilateral agreements, which could put The North American Free Trade Agreement (NAFTA) and potentially the US’s WTO membership on the line under a Trump presidency.

Focusing on more immediate economic policies under Mr. Trump, tax cuts are now likely with a Republican held Congress which would likely boost inflation and help short-term growth. However, long-term implications of inward and aggressive foreign /trade policies are clearly likely to be negative. That said, given Mr. Trump’s history of changing positions, a lot remains to be clarified before stronger judgements on the long-term policy directions and by extension investment implications can be made.

Polarisation and Rising Populism Delivers a Result
Polarisation in America across gender, race and party affiliations has been in play for some time. Figure 1. shows the rising divergence between Republicans and Democrats on different issues – a trend which has been in play for more than a decade and accelerated in the aftermath of the global financial crisis of 2008/9. Similarly, distribution of Republican and Democrat views on political values clearly shows a growing gap over the last 10 years. Indeed, based on the extensive work done by Matthew Gentzkow (Stanford University), it seems clear that polarisation is real and a serious issue.

The second major trend, which came firmly to the surface post Brexit, has been the rise of populism which is now firmly cemented as the new reality in the western world. As shown in Figure 3 below, the collapse of centre-left in advanced economies – which is now becoming a major driver of political outcomes. A trend which requires watching in some of the key elections in European countries over the next 12 to 24 months.

Conclusion
Overall, we continue to recommend caution when it comes to extrapolating Mr. Trump’s campaign rhetoric and believe markets will be subject to increased volatility as this gap is reassessed in coming days and weeks. Any effort by Mr. Trump to bring immigration/anti trade issues on the table will likely be negative for risky assets, while unlike Brexit, bonds may not provide the necessary buffer as they are pulled in the other direction by the potential fiscal easing that will require a more hawkish Fed in the future.

Figure 1
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Figure 2
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Figure 3
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Important Information:
This document has been prepared by Lombard Odier Funds (Europe) S.A. and is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393.

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