Country Risk Commentary: "Politics & Poker"
Scott MacDonald, PhD
|November 14, 2016|
Short-Term Outlook: The electoral victory of Republican Donald Trump as the next President of the USA (POTUS) has clearly changed the investment landscape - to put it mildly. With a view that he will pursue a fiscal stimulus-led economic growth plan, a wide range of equity sectors have enjoyed a new risk-on environment, while interest rate-sensitive sectors (utilities and telecommunications) and technology have lagged. At the same time, the bond market, very sensitive to rates, has sold off with a fair amount of vigor. The main drivers for debt and equity markets are going to be announcements of Trump appointees and policy initiatives. What markets are sensitive to is the appointment of more pragmatic people to key posts, such as Treasury, Defense, and State. On the policy side, the stated priorities are healthcare, tax reform and immigration, but trade policy probably looms largest over all of these, considering that the launching of trade wars with Canada, China, Japan and Mexico would have negative consequences for the US. and global economies. The selection of Reince Priebus over Steve Bannon for the position of White House Chief of Staff was a smart move, as Trump will need someone well-connected to deal with the Republican Party. Bannon is perceived as the hard edge to Trump's populism and in the past has had bad blood with Paul Ryan, Speaker of the House.
Looking ahead in the short term we see a tug-of-war between a pragmatic Trump and a populist Trump, which will be reflected in personnel selections and policy statements, which, in turn, will impact markets and no doubt inject volatility. We still have the Fed raising rates at the next FOMC (), but caution investors to keep an eye on the referendum in Italy on reform. If Prime Minister Matteo Renzi fails to pass the vote for reform, the risk is that his government will fall, which could introduce Europe to its next crisis. Stay tuned.
10-Year US Treasury: 2.233
VIX Index: 15,14
Lucky 7 Fear, Phobia and Risk Monitor
1. US. Politics: While Trump supporters have celebrated their candidate's remarkable win, many Democrats remain in shock and a number of them have taken to the streets in major cities to vocalize their discontent. This puts pressure on the President Elect and President Obama to calm the waters in that the transition will go smoothly. Moreover, Trump needs to make the shift from being a candidate with some extreme policy views to more moderate policy initiatives. The US. political landscape is sharply divided and the election was close, especially considering that Clinton won the popular vote, though failing in the Electoral College.
2. US. Macro: This concern is directly linked to the first fear, phobia and risk factor. We have had a long economic recovery since 2008; while the recovery can continue in a sluggish mode of sub-par growth, a number of problems clearly exist, including the housing market, a build-up in debt, and weak industrial production. Trade is another concern. The new Trump administration holds out the option to stimulate growth via fiscal stimulus, which means that debt will still have to be issued, which, in turn, means that there will have to be buyers, which means that embarking on trade wars with China and Japan, which each hold a little over $1 trillion of US. Treasury bonds, may not be a good idea.
3. Italian Referendum: This could be Europe's next crisis if the standing government of Prime Minister Renzi loses big to the opposition to easier reforms. There is increasing talk of the "Italeave" if Renzi loses and the Five Star Movement is able to force a new election. The Five Star Movement wants to take Italy back to the lira, cut taxes and increase social spending, not exactly a policy mix that will make investors comfortable in financing a debt burden that is over 130% of GDP. This is the country to worry the most about as a European flashpoint.
4. Brexit: There are many unknowns here and the High Court's recent decision that the process has to go through Parliament adds one more factor.
5. Trade Protectionism: Global trade is stalling and the rise of protectionism has an echo to the 1930s. Canada, China, Mexico and Japan are carefully watching the incoming Trump administration's commentary in this area.
6. European Banks: German and Italian have banks have been in the press over the past year and many of the problems they face in terms of capital adequacy and profitability remain a concern.
7. China's credit bubble: President-elect Trump and China's President Xi apparently had a cordial telephone conversation and vowed to work together. At the same time, Trump remains committed to doing something about China's large trade surplus with the US. and Xi's government has quietly let it be known that US. tariff hikes would incur retaliation, including a boycott on buying more US. government dent among other things. China is deeply concerned that a damaging trade war with the US. would cause a recession, which has a multitude of socio-political implications the least of which is diminished the expectations of a growing Chinese middle class. The Chinese also point out that if they go into recession, that would probably pull the US. into a recession as well.