What a whirlwind ride we’ve been on over the past 24 hours.
Fear and jubilation, Jekyll and Hyde, chalk and cheese — however you describe the moves in financial markets, it’s been a remarkable turnaround for riskier assets such as stocks and commodities, along with US treasury’s, a well known safe haven for investors.
After doing the exact opposite in Asia, stocks and commodities ripped higher in European and US trade while US treasury’s were slammed, sending the yield on the benchmark 10-year note hurtling back above the 2% level for the first time since early March.
The reaction has baffled many market analysts, except those from the Commonwealth Bank, that is.
Here’s the view conveyed by Richard Grace, Elias Haddad, Joseph Capurso and Wei Li, members of the bank’s economics and strategy team, on why the markets reacted the way they did.
Making the call all the more impressive, at least so far, it was written in late September.
We make the observation that Trump’s economic policies are very inflationary. Assuming Trump’s policies pass Congress, we anticipate higher US bond yields, a flatter yield curve, higher US equity markets and a stronger US dollar.
Trump proposes to dramatically reduce income taxes to lift household and business spending. The US economy would grow at a more rapid rate given household consumption accounts for 70% of US GDP. Trump also proposes to cut the company tax rate to 15%, from its current scaled variable rate of between 15% and 35%. We believe this would result in a higher re-rating of US equities as increases in net-profit-after-tax valuations surge, generating larger capital inflows into the US economy. US corporates would repatriate profits now subject to less tax into the US economy, further lifting the USD.
Trump proposes to boost infrastructure spending and abolish regulations that inhibit job growth. However, there are no details provided, and the inflationary impulse from these particular policies are likely to evolve over a period of time
Trump proposes to lift a host of environmental restrictions that inhibit energy investment. While the actual investment spending is modestly inflationary, the net impact on the oil price is uncertain because increased oil and energy supply should put downward pressure on oil prices, but the extra demand generated from Trump’s policies will be supply-absorbing.
Trump proposes to “label China as a currency manipulator”, renegotiate NAFTA and “apply tariffs and duties to countries that cheat”. All of these policies are very protectionist and would result in higher US import costs, higher US inflation, and lower US exports even if China and other countries do not retaliate. Some trade would bypass through third country economies.
Despite the widening in both the US budget and trade deficits under the above outcomes we think the USD will lift up to 10% before correcting lower some twelve-months later.
Not a bad call, and one that markets seemingly agree with given the price action overnight.
After thinking the exact opposite only hours ago, investors have now adopted the view that Trump’s policies will be help to boost economic growth, create jobs and prove inflationary.
This has, at least for the moment, helped to steepen the US yield curve, bolster confidence in stocks and commodities and helped underpin a solid rally in the US dollar.
The key question now is whether that sentiment will last. The answer is anything but certain.
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