The Trump reflation trade — centred around the premise that increased fiscal stimulus in the United States will lead to faster economic growth, higher inflation and, as a consequence of both, tighter monetary policy from the US Federal Reserve — has been a powerful force across markets since the US presidential election.
Bonds have sold off aggressively while stocks, industrial metals and bulk commodities have rallied hard.
According to Alan Ruskin, global head of G10 FX strategy at Deutsche Bank, the “Trump trade” is only in its infancy at this point, suggesting that the initial market reaction — premised on the belief that the US economy will strengthen — is only the first stage of five that will play out in the years ahead.
And now the true test of the optimism underpinning recent markets moves will almost certainly be put to the test.
“Without getting too cute about it, there are probably five defining stages for the ‘Trump trade’,” he says: “Trading ‘the promise’; the deal-making; the enactment; the economic impact, and, the payback.”
Here’s are the five stages of the Trump trade, according to Ruskin, including why he believes the first stage, and perhaps the easiest of all — trading the the promise — is now over.
1) The promise stage is done. It has been powerful, precisely because it has involved a possible paradigm shift in cyclical stimulus and because the expected US policy mix is seen as so differentiated from the rest of the world.
2) The deal-making phase will take shape over the next 100 days. Here we will start to get a better feel for the scale of fiscal stimulus, and therefore the spillover onto monetary policy. The complexity of far-reaching changes could stretch this phase, making for more frustrating trade conditions, especially since the Fed is not under too much pressure to front-load their actions, without more clarity on fiscal policy.
3) For the enactment phase where deals are signed off on in H2, the market will be particularly responsive to issues that relate to timing of impact; multiplier effects; the breakdown not least as it relates to far reaching corporate tax reform that will impact trade patterns, FDI, equity and bond flows; and, protectionist elements where retaliation is a real threat.
Not to be forgotten in this phase is the overlap with changes in key Fed personnel, including the Fed Chair appointment. The talk of a more rules-based Fed, or at least having the Fed Chair explain departures in policy from a rules-based system, is apt to be seen as hawkish, especially given how accommodative policy is now.
4) The economic impact phase. The growth impulse will likely be felt mostly in 2018, with questions on how much the upturn is accelerated and elongated into say 2019. The inflation impulse could have even longer lags, unless there is a border adjustment tax that hits import prices quickly. This will be a phase where we better understand how much the Fed will tighten in this cycle and whether the peak in the USD is in 2018 or even beyond. If there is a genuine acceleration in growth, the market could make sizable adjustments in Fed expectations, and this may well prove another important period for trending markets.
5) The payback phase. Fiscal stimulus often brings growth forward, usually with a payback in the form of slower growth as the stimulus wears thin. Similarly, there is a reversal in financial prices. Think of this as the equivalent of what we saw for the USD in the 1982–84, where the rally gave way to ‘the payback’ of a much weaker USD in 1985-87. In current circumstances payback is more relevant for 2019 and beyond.
With the second stage of the Trump trade now upon us in his opinion, Raskin says that it’s important for Trump to use his political capital wisely, noting that nine of the past 12 Presidents saw their popularity “peak and leak” within months of their inauguration, making it progressively more difficult to get things done.
Given this past trend, he says that deal-making phase is frustrating for markets as the wrangling between what Trump wants, and what he can actually deliver, plays out.
“The more complex the fiscal package, the more far-reaching the implications, the less chance it becomes law, for any far-reaching tax reform is inherently disruptive to entrenched interests, and these interests then work to undermine Congressional support for change,” says Raskin.
“The phase of deal-making may then prove much more frustrating for markets, unless factors that can set off new outlook for inflation, the trade balance, and the Fed — like the border adjustment tax — look likely to gain passage.”
Raskin says that once the proposed policies are turned into law, whatever form they may be, markets will have a clearer sense on the timing and reach that they will have on the economy.
He remains optimistic that Trump will be able to deliver on at least some of his proposed policies, suggesting that even a modest fiscal package will result in further US dollar strength, particularly with the Fed the only major central bank likely to tighten monetary policy in the year ahead in his opinion.
“Importantly for USD bulls, fiscal initiatives should be seen as the ‘icing on the cake’,” he says.
“Even a moderate net fiscal stimulus of say 1% of GDP without far-reaching tax reform or border adjustment taxes can justify modest USD strength (~5% on the TWI).
“Border adjustment taxes with its impact on trade, inflation and Fed policy, would simply make the story overwhelming.”