President Trump (POTUS) at the White House

The results of the US elections at 7.37am CET this morning were favorable to Donald Trump. The NY Times rates the probably of a Trump victory at 95%, while for CNN the likelihood of a Clinton victory is rapidly waning.
Trump’s victory in swing states such as Florida, Ohio and North Carolina seems to indicate that the Republican candidate will be the next resident of the White House.

The markets have spontaneously adjusted very dramatically, with the Mexican peso plummeting and gold rallying. The equity markets are down across the board, and the 10 year US rate is falling sharply.

 Trump’s likely victory drastically alters the world economic scenario.

The main risk is that the country will turn in on itself, undoing the effects of 40 years of globalization. At the start of the 1980s, the simultaneous arrival of Reagan and Thatcher to power heralded the start of a long phase of globalization, driven by the logic that it cuts back local restrictions and allows for more lasting growth. Victory for the Brexit camp in the UK followed by the possible Trump victory reverse this trend.

The change on this issue is drastic as all of a sudden, globalization is no longer the standard framework (read here). The 1980s went fairly well in the end due to liberalization measures implemented, particularly on the capital markets, which reduced restrictions that weighed on the economy.

This time, there will be trade restrictions.

The Trump campaign was broadly based on the idea that the rest of the world is responsible for the deterioration in the situation in the US. We should therefore expect a strategy that is primary American-centric. This will involve reconsideration of treaties to which the US is a signatory and in this respect the US president has considerable leeway as he can act without Congressional approval. This means that things can move very quickly. Although in view of the elections currently taking place in Congress, the Republican president will be able to rely on a majority there anyway, which will increase the impact of any steps he takes.

We note the following points:

1 – the US may opt out of existing treaties, even going so far as taking the country out of the World Trade Organization (WTO). This would enable the US to set its own rules with no counterbalancing force.

This would lead to two situations:
Firstly, the US would have freedom of action in trade without being bound by past pledges, particularly on commitments to Mexico via NAFTA.
Secondly, the exit from or the threat of the exit from the WTO will enable the US to freely set customs duties. This will particularly affect China.

2 – Current negotiations on trade treaties with Asia excluding China (TPP) and with Europe (TIPP) have little chance of being finalized.

3 – The US wants to scale back its political commitments with the rest of the world. The Republican candidate thinks that defense of the western world’s freedom is a public benefit that carries a high price tag for the US. Reduced involvement in world affairs could be a cause for concern for Europe as the political balance could shift, particularly in light of Putin’s offensives.

In all countries across the world where the US intervenes, this could trigger instability and uncertainty.

The consequence is the risk of a severe and persistent shock on world trade. This will affect the entre world, not just countries that are specifically targeted by Republicans. We can expect retaliatory measures from countries that are targeted explicitly, and there is a risk of breakdown for the entire global economy. The risk of a world recession is substantial.

From a US domestic standpoint, pledged tax cuts will be implemented, leading to a significant increase in imports. The aim of this move is to boost Americans’ income and drive spending. However, the US is dependent on supply from the rest of the world for a large proportion of its manufacturing sector.

This will set the scene for some interesting situations as the divergence between the two points above will have to be resolved: imports are set to increase to meet domestic demand, while world trade will be hit by the aforementioned shock and imports will suffer higher customs duties. This contradiction increases the risk of a recession by heightening the imbalance between domestic policy and the shock on world trade momentum.

The world was not in great shape and is set to get even riskier, and this is a bad sign for all risky assets, which fell this morning. Meanwhile, long-term rates are on a downtrend.

Other points to note
The contradiction between domestic momentum and the restrictions resulting from the shock on world trade and the increase in customs duties will trigger more inflation in the US, as domestic production will not immediately be able to meet rising demand, thereby creating upward pricing pressure. The increase in customs duties will heighten this trend.

Meanwhile, the Fed is in a risky situation. The likelihood of a rate hike in December is decreasing sharply, and looking beyond this point, the institution’s very independence is set to be questioned
There is also doubt over the signature of the climate change agreement (COP 21).

These various factors are worrying and negative signs for both the US economy and the world economy as a whole. The context is shifting dramatically, but we do not know to expect from the new world order. We cannot believe that this inward-looking strategy is the right approach as it reflects a non-cooperative and uncoordinated attitude.

Not to mention issues on abortion, arms, immigrants, the wall with Mexico…..

The Fed is ready for December

In its press release (see here), the Federal Reserve said that pressures on prices are a bit stronger. Therefore the probability of a rate hike at the next meeting in December (13/14) is higher.
Discussions on inflation are the main change seen in the press release when it is compared to the previous one in September.  (see here) The Fed also noticed that consumers expenditures have a lower momentum.
The Federal Reserve wants to have larger margin in the management of its monetary policy and that’s the main reason for the expected change in rates.
The Fed is very attentive to the asymmetric dynamics associated with its monetary policy. Acting too early is taking a risk on the economic activity, the Fed doesn’t want that. It prefers acting later even if it is at the price of higher inflation. We are in this configuration.
It will act in December to have margin but will not send strong guidances for 2017 as there are a lot of uncertainties for the US economy and for the world economy. It wants to keep its ability to manage its strategy without tying its hands. I already mentioned that point here
The target is not to constrain the economy but to have margin without changing too much investors’ expectations. That’s a real challenge

NB: I make the implicit hypothesis of a Clinton victory at next week presidential election. A Trump victory would change the picture. I have wrote (in French here) that the risk with a Trump victory is a negative shock for the global economy. In that case the Fed could be on a wait and see mode.

The Inflation rate will accelerate temporarily

The stabilization of the oil price around USD 50 implies that the contribution of the energy sector to the inflation rate converges currently to 0.
In October for the Euro Area, this contribution was only -0.09%, its highest number since June 2014. The profile is the same in the US.
The point is simple. The current oil price is comparable to the price seen one year ago. This wasn’t the case since mid-2014. Therefore the energy contribution to the inflation rate was systematically negative as the oil price was lower than a year before. As prices are currently comparable the contribution converges to 0 Continue reading