Investors around the globe are digesting the reality of Donald Trump’s surprise (to many) victory over Hillary Clinton. Here’s our view on what a Trump presidency and Republican Congress likely mean for markets over the near, medium and longer terms.
- Greater uncertainty and higher risk premia: Volatility is likely to stay elevated relative to recent levels. At this point, given 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 – what is unknown about the outlook outstrips what is known.
- We see potential risk of financial asset price pressures from the unwinding of risk parity and volatility-targeting strategies.
- A strong U.S. dollar relative to emerging market risk currencies is to be expected on a generic basis, although some have already cheapened substantially. We see a more muted picture for the dollar versus developed market reserve currency alternatives.
- Rapidly shifting inflation expectations and an expected increase in the supply of Treasuries will likely keep the pressure on long-dated nominal Treasuries, but inflation-linked Treasuries (TIPS) and proxies are likely to continue to do well (as we had been flagging for some time).
Near to medium term
- Near-term tightness in some financial conditions and concerns about trade frictions may be drags on growth, but likely will be overpowered by the probability for fiscal loosening over the medium term (lower taxes, increased infrastructure spending). 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. Potential for less expansion in the regulatory burden is also likely to boost business confidence and investment spending, as does the strong prospect for a “Homeland Investment Act 2” type of U.S. dollar repatriation deal.
- Inflation and monetary policy: We see a higher and more balanced inflation forecast and more rapid normalization of policy. Expect markets to move from pricing in a permanent lagging of the 2% inflation target to viewing an overshoot equally likely. Ultimately, we think this means 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. That said, near-term uncertainty may slightly reduce the probability of a move in December. And we think it’s too early to say what influence Trump may have on central bank leadership and its reaction function, as new appointments are required to fill existing vacancies and Chair Janet Yellen’s term expires in 2018.
- We could see a secular rise in populism, political risk factors and related uncertainty, as our cyclical and secular outlooks have acknowledged. We see potential positives and negatives associated with these trends: There is perhaps more potential for structural reform and a break of the gridlock in Washington, but counterbalanced by risks of a too-rapid forcing of trade adjustments.
Scott Mather is CIO of U.S. Core Strategies and a member of PIMCO’s Investment Committee. He is a regular contributor to the PIMCO Blog.