With the election of Donald Trump, many Wall Street analysts are attempting to figure out just what the economy will look like under his presidency.
And though there is still a lot of uncertainty, they are near unanimous on one thing: Donald Trump’s policies will most likely bring about a significant uptick in inflation.
In other words, the price of everthing in America may be about to head north.
It was one of the dominant trades on Wall Street on Wednesday, after Trump’s surprise victory.
There was a “broad-based rise in inflation swaps” on Wednesday, according to Bruce Kasman at JPMorgan. A macro salesman put it more simply. When asked what he was seeing early Wedesday, he said: “Massive bid for inflation.”
“Donald Trump’s platform has an inflationary bias: his fiscal policy is likely to be expansionary, and he leans toward protectionism, which is inflationary due to the effects of tariffs and curtailed immigration,” said Mark Haefele, the Chief Investment Officer at UBS in a note to clients.
Let’s break that down in to its two constituent parts: increased government spending and trade barriers.
In the lead up to the election, Trump’s campaign laid out a plan for $1 trillion in public and private investment in infrastructure that generates revenue such as toll roads and airports.
According to analysts, the combination of a tight labour market and increased money supply in the economy would put pressure on prices. The US is already operating at near full-employment, and Trump’s commitment to tighten the borders and deport immigrants could potentially reduce the labour force further.
“US fiscal stimulus (which is not currently built into our US or global outlook) would boost global demand,” wrote Kasman, head of economic research at JPMorgan. “With most of the benefits of this stimulus accruing to a US economy operating close to full employment, it would likely increase US and global inflation.”
Essentially, with wage pressures already rising in the economy — higher wages are thought to lead to businesses increasing prices — increased hiring for these projects would lead to broader price increases.
Increase of trade barriers
As noted in Trump’s speech outlining his first 100 days, one of the key focuses is changing the way America trades with the rest of the world by “renegotiating” deals such as the North American Free Trade Agreement and pulling out of the Trans Pacific Partnership.
Analysts believe that these changes will most likely be protectionist and lead to inflation. Increasing trade barriers could include tariffs, or taxes for importing or exporting goods, making it more expensive to import parts for goods.
“Restrictive trade policies slow activity and boost inflation in early 2017 as a marked shift in public policy alters the landscape in a way that reduces the intensity of tradable activity while encouraging domestic production and consumption,” said Michael Gapen, chief US economist at Barclays.
As noted by the anonymous finance blogger Macro Man, the PCE price index for durable goods (anything that lasts more than two years, i.e. cars or computers) peaked right before the passage of NAFTA and has been declining ever since. Thus, a more protectionist trade agreement could lead to higher prices for those types of items.
“Altering trade deals to get a ‘better deal’ for America is likely to increase inflation via reduced supply,” wrote Kevin Gaynor and Sam Bonney, strategists at Nomura. “Reducing the labour force is aimed at increasing wages. Onshoring is aimed at increasing jobs and, presumably, real wages along with corporate costs.”
As with many of Trump’s policies, however, there is some question to the extent that they will be carried out.
“One thesis is immediate tariffs are a negative supply-side shock, lifting inflation and undermining growth,” said Alan Ruskin at Deutsche Bank. “The open question is how far Trump embarks down this path, or whether he opens the door to pragmatic renegotiation of trade agreements that again has some parallels with the UK, albeit the US will be negotiating from a position of strength.”
Impact on the Fed
The increased inflation pressures will have a widespread impact on consumers, businesses, and the Federal Reserve.
For the Fed, it appears that the long awaited inflation may lead them to increase their rate of interest rate hikes.
“I would expect there to be more fiscal spending in the future that will accelerate any potential inflation in the system,” Jerry Haworth, CEO of London-based hedge fund 36 South Capital Advisors told Business Insider’s Ben Moshinsky. “The quicker inflation returns, the quicker interest rates may go up.”
The increase of interest rates, however, could work one of two ways.
On the one hand, inflation has been running well-below the Fed’s desired 2% target for years, so some inflation would help to reach their policy goals. Stable inflationary increases would allow the Fed to raise interest rates to a level that is more in line with the long-term norm, giving them room to drop rates when the next recession comes.
On the other hand, inflation has already naturally progressed closer to the 2% target with core PCE slightly above 1.7% at its most recent reading, well above its 1.3% mark in December of last year.
Thus, highly inflationary policies coupled with already progressing inflation could lead to a surge in price increases. This would put the Fed behind the curve and in the worst case force them into a furious series of rate hates from their current historically low rate, in turn dampening economic activity.
Impact on Businesses
As with the Fed, there are two ways this could play out for the largest businesses in America.
In the positive scenario, increased pricing power allows companies to pass along higher wages and input prices to consumers, maintaining margins and continuing strength in the corporate sector.
In the negative scenario, the increased tariffs make life more expensive for companies, and wages do not keep track with the rising coasts, crushing margins. Additionally, those companies that do business outside of the country (roughly 33% of revenues for the S&P 500 come from overseas) could take a hit if the Fed raises rates, as a stronger dollar would hurt the value of revenue generated overseas.
Impact on consumers
As companies look to American workers to replace immigrants, and new fiscal stimulus jobs require more workers in an already tight labour market, wage pressures would likely increase.
On the other hand, Trump’s trade plans will also make purchasing goods more expensive, especially those shipped from overseas. Things like iPhones, cars, and even foods that are sourced from outside the US would become more expensive with higher tariffs.
It’s not all certain
Now, a few caveats here. For one, it is unknown how many of these polices Trump will actually pass. Even in his own party there are deficit hawks that may not be agreeable to the idea of large scale fiscal stimulus.
During President Obama’s term, in fact, many Republicans were against a stimulus package that was smaller than Trump’s and came in the depths of a recession, when stimulus is thought to be most effective.
Additionally, Trump himself has laid out broad policy proposals but not finer details — especially on trade — so the exact nature of the president-elect’s plan is unclear.
Thus, as with many things over the coming months, we’ll just have to wait and see.
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