Even though the acute weakness in stocks and the US dollar, along with the big rally in bonds and gold, were swiftly reversed in wake of markets’ reappraisal of the impact of a Trump presidency, that doesn’t mean the uncertainty has ended.
That’s the view of Scott Mather PIMCO’s chief investment officer for US core strategies. In a note, Mather set out PIMCO’s view “on what a Trump presidency and Republican Congress likely mean for markets over the near, medium and longer terms”.
In the immediate future, Mather doesn’t believe the volatility of election night is going to fade away. Rather, he says greater uncertainty and higher risk premia mean “volatility is likely to stay elevated relative to recent levels”. Mather says that’s due to “uncertainties about Trump’s policy agenda, key government leadership positions and likely changes in foreign and trade policy – and world government and market reactions to those shifts”.
The risk Mather sees immediately are an unwinding of “risk parity and volatility-targeting strategies” which can add to financial price pressures. He’s not overly bullish the US dollar against the majors but sees a strong US dollar against emerging market risk currencies persisting.
PIMCO also sees continued upward pressure on US interest rates from “shifting inflation expectations and an expected increase in the supply of Treasuries”.
Looking a little further out in the near- to medium-term, Mather sees the potential for drags on economic growth from tightening financial conditions and trade concerns but believes these will be overwhelmed by fiscal loosening.
“Prospects for meaningful tax reform and infrastructure spending (pro-growth structural reform) could boost prospects for growth considerably over the coming years, although it’s hard to put numbers on this yet,” Mather said.
Less regulatory burden could also be economically expansionary, as is the “strong prospect for a Homeland Investment Act 2 type of U.S. dollar repatriation deal”.
That all means that PIMCO believes there will be “a higher and more balanced inflation forecast and more rapid normalization of policy” and the market repricing inflation in the US back above 2%.
Mather says “the Fed will move faster on rate increases than the market had been pricing for in the year ahead, but still in line with our forecast for two to three rate hikes before the end of 2017”. But the increase in uncertainty also means Mather sees a reduced probability of a December rate hike from the Fed.
Longer term, the “secular rise in populism, political risk factors and related uncertainty” will continue but there are potential positives and negatives from these trends.
The potential for a break of Washington gridlock and structural reform are to a certain extent counterbalanced by “risks of a too-rapid forcing of trade adjustments”.
All of which is the challenge of a Donald Trump presidency. The US, the globe, needs a reflationary pulse and Trump seems set to deliver it in the US if he follows the policy prescription of his candidature. But it comes attached with much uncertainty, as PIMCO highlights.
For the time being, some extension of volatility seems assured as a result.