President Trump has started to put his campaign promises into action. What should we expect?
By Venture Staff
Among the chaos of the new Trump administration lies the most important economic policies that have yet to be implemented. Prior to the elections, the pickup in the economy was already evident. While Trump has debated grandiose strategies (and equally haughty rhetoric to accompany them), understanding his economic policies is a complex task. Not to mention, Congress will be adamantly austere, despite it remaining under Republican control.
Trump is very (and we mean, very) optimistic about economic growth; he expects GDP to grow by 4 percent in the short-term, with anticipation for further increases to 5 and 6 percent in the medium-to-long-term. This means that growth will accelerate above the 2.2 percent average annual rate witnessed during Obama’s second term. This is because with a Republican president, Congress has always been willing to boost public spending and relax debt limits, as was under Presidents Reagan and George W. Bush, versus under Democratic Presidents Obama and Clinton.
Trump’s key policy pillars are infrastructure investment, regulatory reform, refinancing debt, tax cuts, tightening immigration, overhauling Obamacare, otherwise known as the Affordable Care Act, and refocusing on bilateral rather than multilateral trade deals. Although the Trump agenda covers more than these areas, they represent the most influential factors for the short-to-medium economic and market outlook.
- Infrastructure investment:
To meet his ambitious 4 percent growth target, Trump is expected to implement Keynesian-style fiscal stimulus that his predecessor pushed for but was unable to deliver. If Trump is successful, many expect growth and inflation to increase. It is important to note that economists estimated 175,000 new jobs created in January 2017, the 76th consecutive month of job growth under President Obama. This left the unemployment rate at 4.7 percent versus a high of 10 percent in October 2009, meaning the United States has almost reached full employment. With the additional growth, this will push inflation higher. Should there be any adverse consequences, it will only happen in the medium-to-long-term.
A major underpinning to the aforementioned growth strategy is Trump’s initiative to invest $1 trillion in rebuilding the US’s infrastructure over the next 10 years. Investments can only render from private funding, meaning the money will be invested in projects funded by tolls or other user fees. Congress will most likely show little appetite for the plan, which already is short on details, due to the fact that it could cost billions of taxpayer money and drive the national debt to skyrocket should private funding be insufficient. Although the plan is used to drive economic growth, not all benefits can outweigh costs in this case.
- Deregulation and repeal of Dodd-Frank Act:
Another boost to economic growth could come from regulatory reform of financial institutions. This is difficult to evaluate given the lack of specifics so far. Key initiatives backed by Trump on energy and environmental regulations have dominated headlines, such as the controversial Dakota Access Pipeline. The biggest economic impact will likely come from rolling back bank regulations, namely the Dodd-Frank Act, which was created in response to the 2008/09 economic crisis. Although the act has several flaws, many believe it made the banking system safer through its requirement that lenders hold more capital for extra cushioning in times of need. Trump claimed this discouraged banks from making loans, and therefore limited growth. Overall, dismantling an act that was passed by Congress will need to go through them again, which will take much debate and time.
- Refinancing debt:
Trump believes the Fed should refinance debt to reduce interest payments. Refinancing existing debt is done to save money (only when rates go down), which raises the question whether the Fed should continue hiking interest rates. Trump has expressed a desire for low rates to help prevent the dollar from appreciating. Should the Fed follow Trump’s advice, this might lead to more borrowing over the long-term and eventually higher national debt if not managed properly.
- Tax reform:
In September 2016, Trump announced his tax plan, which was his most detailed proposal put forth while campaigning. It covers the implementation of many tax cuts among corporations and individuals whilst boosting public spending. Corporate taxes currently stand at 35 percent, which is the highest among developed economies. Trump’s proposition is to cut this to 15 percent to become among the lowest. His reasoning for this is to increase new business investment, allowing companies to increase their willingness to invest in the economy. However, because the economy is already near full employment, this could imply (on a general long-term outlook) accelerated inflation and/or higher interest rates. Moreover, economists believe this will reduce revenue considerably and consequently expand the federal budget deficit. For example, nonpartisan tax research groups calculated that Trump’s plan would cut taxes by $11.98 trillion over 10 years. This could lead to 11 percent growth in GDP, 6.5 percent higher wages, 29 percent larger capital stock, and 5.3 million jobs. This would reduce tax revenues by $10.14 trillion, even when accounting for economic growth from increases in supply of labor and capital.
Trump is calling for reducing income tax rates from seven to three brackets: 12 percent, 25 percent, and 33 percent. The difference in the top tax rate between a paid employee (33 percent) and an independent contractor (12 percent) is significant. His plan also calls for the increase in the standard deduction to $15,000, up from $6,300 for single filers, and to $30,000, up from $12,600 for married couples. Research groups concluded that his plan could reduce federal revenue by between $4.4 trillion and $5.9 trillion. Nonetheless, a durable impact on middle-class consumerism will only be noticed in the medium-term.
Trump has promised to maintain entitlement programs such as social security and Medicare, two of the costliest parts of the federal budget. In the face of a large deficit, creditors could demand higher interest rates on US bonds, implicating investor sentiment and creating negative market reactions.
- Immigration Plan:
Trump’s immigration executive order is to suspend refugee resettlement and block individuals from seven majority-Muslim nations from entering the United States, as well as the deportation of undocumented residents. According to some analysts, if these policies are enforced, it would cost the federal government between $400 billion to $600 billion, shrink the labor force by 11 million workers, reduce real GDP by $1.6 trillion, and take 20 years to complete (Trump said he could do it in 18 months). Additionally, quotas on immigration could have a negative impact on retail sales, housing starts, and housing prices. A number of industries that depend heavily on cheap immigrant labor would also be devastated, especially agriculture.
- Health Care:
While campaigning, Trump outlined a seven-point plan for health care in the United States, which included repealing Obamacare (later revised to reforming it), allowing purchases of health insurance across state lines, as well as block-granting Medicaid to states. This would allow consumers to re-import drugs from overseas, for example. Trump is expected to submit his health care reform plan based on a pre-Obamacare baseline, which researchers conclude that such a system would result in 7 million more people being insured by opening up the insurance markets to more competition.
Trump views trade as a zero-sum game, which could mean the United States will be shifting away from free trade, open markets, and globalization. The impact of his policies could be detrimental to economic and political ties with many developing countries, and in turn resulting in a negative impact on emerging businesses and multinational corporations. Trump has threatened to impose a 45 percent tariff on imported goods from China, up from the current 3 percent, and impose a 35 percent tax on automakers in Mexico.
Trump has proposed negotiating with China to prevent it from manipulating its currency and keeping it too low for US manufacturers from competing. When China devalues its currency, goods produced there would become cheaper, while US products become more expensive, and thus unappealing to purchase. As such, Trump’s policies to prevent Chinese currency manipulation is to help increase US jobs, local production, and improvement in competitive advantage. It is uncertain whether China will comply.
Trump is also not a fan of NAFTA or the Trans-Pacific Partnership (TPP), upon which he already withdrew the United States from the TPP trade agreement. The TPP aimed to reduce trade barrier among seven nations of the Pacific: Japan, Vietnam, Malaysia, Singapore, Australia, Brunei, and New Zealand.
Overall, the implementation of Trump’s aforementioned policies could lead to both a positive and negative impact on the economy, fixed-income markets and equity markets. The pro-growth Trump agenda of corporate and individual tax reform, infrastructure investment and regulatory reform all appear likely to provide some near-term “extra” boost to economic growth in the United States, although the current lack of details on his policies makes any measureable projection subject to uncertainty.
With Trump’s implementation of order of businesses, many investors have been investing in some of the riskiest bonds sold by US companies as they bet on the president’s delivery of promises. As such, demand for junk-rated bonds has driven yields on debt with low quality credit ratings down to 10 percent. The current market rally has led to raising money to refinance older debt of approximately $41 billion, the largest amount invested since 2013. Overall, people have been more comfortable taking on risk, driven by optimism around new policies.
However, recently, long-term interest rates rose sharply in response to rising inflation expectations and optimism that fiscal stimulus will drive stronger economic growth in the United States. Short-term rates also rose as a result of the December rate hike by the Federal Reserve and its revised expectations for three hikes in 2017. Rising rates are negative for bond performance, but over the long-term, higher rates could boost returns for bond investors in the form of higher income. The transition period can be difficult, but long-term gain can be realized.
The noted bullish investor sentiment is expected to wane in the short-term due to the bearish outlook for the $2.2 trillion US junk bond market. This is led by a $1 trillion “maturity wall” facing lower rated companies over the next five years, and where more than $400 billion of bonds and bank loans come due, a record level according to rating agency Moody’s. Simultaneously, analysts warn that ratings on the loans have “deteriorated significantly,” while bank and nonbank lending standards are not easing, credit card and auto loan delinquencies are rising, and bank commercial and industrial loan growth have stalled. With the implementation of lower corporate taxes, this would free cash for interest payments by companies, while a reduced regulatory burden could bolster margins. Faster economic growth would in turn support higher sales.
As for the US dollar, a further strengthening of it should the US economy grow faster than expected, especially if long-term interest rates rise, could lead to unfavorable consequences on exports and imports. The United States is currently the world’s largest exporter with $2 trillion. Imposing tariffs will lead to countermeasures from other countries, including price hikes. Moreover, even though the dollar is already overvalued, governments and companies in emerging markets could accumulate dollar debts near-zero interest rates, similar to events of the early 1980s and 1990s. On the other hand, the potential for the strength in the US dollar and improved growth could create an environment that may favor domestic stocks over foreign equities, and small companies over large multinationals.
No one can predict with certainty what will be covered in Trump’s legislation that will need to be negotiated, adjusted, amended and ultimately passed, especially that his debated policies lack copious amounts of details. Nonetheless, the overall direction of his procedures is relatively clear. Many critics are underestimating the potential popularity and durability of Trump’s efforts in the coming four years. Yet, only time will tell.