As Deutsche Bank’s Alan Ruskin puts it, without getting too cute about it, “there are probably five defining stages for the “Trump trade”: Trading i) ‘the promise’; ii) the deal-making; iii) the enactment; iv) the economic impact, and, v) the payback.“
Here are the details as market pscyhology shifts from phase 1 to stage 2, which DB says took place during last week’s Trump press conference, and what markets can expect going forward.
The five stages of the Trump trade
Trump’s press conference last Wednesday has probably drawn the line between ‘the promise’ phase, and, the stage where deliverables will become progressively more important. The ‘promise’ stage was never seen extending beyond Trump’s inauguration, since it was always expected that the market would start responding to actual President/Congress initiatives in what is likely to be a very active first 100-day agenda.
To get to the enactment stage it is usually important for the President to use political capital wisely, not least because 9 of the last 12 Presidents saw their popularity near peak and leak within months of their inauguration, making it progressively more difficult to get things done. However, in current circumstances, much of the impetus and detail on fiscal reforms, including ‘market hot buttons’ like the border tax adjustment, already have considerable Congressional impetus, not least from the Ryan – Brady tax plan.
One difficult assessment, is the trade-off between the ambitions of a fiscal package and its likely legislative progress. The more complex the fiscal package, the more far-reaching the implications, the less chance it becomes law, for any far-reaching tax reform is inherently disruptive to entrenched interests, and these interests then work to undermine Congressional support for change. There is little doubt that the more complex aspects of a comprehensive tax plan could, and probably will, push the deal-making phase into the 3rd quarter. The phase of deal-making may then prove much more frustrating for markets, unless factors that can set off new outlook for inflation, the trade balance, and the Fed – like the border adjustment tax – look likely to gain passage.
Once plans are turned into law, the market will have a clearer sense on the timing and reach of the main growth impulse. We would expect that asset markets will at least partly ‘front-run’ the growth impulse, with the extent of the ‘discounting’ dependent on the confidence over timing and scale of the growth implications.
So what does this mean for the 5 stages of the Trump trades?
- i) The promise stage is done. It has been powerful, precisely because it has involved a possible paradigm shift in cyclical stimulus and because the expected US policy mix is seen as so differentiated from the rest of the world.
- ii) The deal-making phase will take shape over the next 100 days. Here we will start to get a better feel for the scale of fiscal stimulus, and therefore the spillover onto monetary policy. The complexity of far-reaching changes could stretch this phase, making for more frustrating trade conditions, especially since the Fed is not under too much pressure to front-load their actions, without more clarity on fiscal policy.
- iii) For the enactment phase where deals are signed off on in H2, the market will be particularly responsive to issues that relate to timing of impact; multiplier effects; the breakdown not least as it relates to far reaching corporate tax reform that will impact trade patterns, FDI, equity and bond flows; and, protectionist elements where retaliation is a real threat. Not to be forgotten in this phase is the overlap with changes in key Fed personnel, including the Fed Chair appointment. The talk of a more rules based Fed, or at least having the Fed Chair explain departures in policy from a rules based system, is apt to be seen as hawkish, especially given how accommodative policy is now (fed funds is tracking 100 – 125bps below a Taylor Rule signal).
- iv) The economic impact phase. The growth impulse will likely be felt mostly in 2018, with questions on how much the upturn is accelerated and elongated into say 2019. The inflation impulse could have even longer lags, unless there is a border adjustment tax that hits import prices quickly. This will be a phase where we better understand how much the Fed will tighten in this cycle and whether the peak in the USD is in 2018 or even beyond. If there is a genuine acceleration in growth, the market could make sizable adjustments in Fed expectations, and this may well prove another important period for trending markets.
- v).The payback phase. Fiscal stimulus often brings growth forward, usually with a payback in the form of slower growth as the stimulus wears thin. Similarly, there is a reversal in financial prices. Think of this as the equivalent of what we saw for the USD in the 1982–84, where the rally gave way to ‘the payback’ of a much weaker USD in 1985-87. In current circumstances payback is more relevant for 2019 and beyond.
While each of these five stages is likely to have its own defined characteristics, there is apt to be plenty of overlap. Importantly for USD bulls, fiscal initiatives should be seen as the ‘icing on the cake’. The Fed was lining up to be the only G10 Central Bank to tighten in 2017, whoever was elected. Even a moderate net fiscal stimulus of say 1% of GDP without far-reaching tax reform or border adjustment taxes can justify modest USD strength (~5% on the TWI). Border adjustment taxes with its impact on trade, inflation and Fed policy, would simply make the story overwhelming.
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