Fo­cus may drift back to Fed and in­fla­tion

Trump vic­tory poses ma­jor chal­lenge

Kuwait Times - - BUSINESS -

BEN­GALURU: Af­ter Don­ald Trump’s un­ex­pected vic­tory in the US pres­i­den­tial elec­tion, in­vestors may re­fo­cus in the com­ing week on the health of the world econ­omy and any signs that years of rock-bot­tom in­ter­est rates and fis­cal aus­ter­ity are com­ing to an end. Trump’s vic­tory poses a ma­jor chal­lenge to the con­ven­tional wis­dom on the global econ­omy, which for years has re­lied on brisker cross-border trade and mi­gra­tion flows for growth.

Apart from a nearly across-the-board rise in sov­er­eign bond yields, how­ever, the markets have so far mostly shrugged off the elec­tion re­sult - de­spite pre­vi­ous fears of a melt­down in the event of vic­tory for Trump, who es­poused fiercely pro­tec­tion­ist po­si­tions on trade in his cam­paign. Even the long-held view that the Fed­eral Re­serve will raise rates next month, a year af­ter its ini­tial step in that di­rec­tion, hasn’t budged at all. Fed Chair Janet Yellen’s tes­ti­mony to Congress on Thurs­day may set the stage for a yearend hike, de­spite the mild tight­en­ing in fi­nan­cial con­di­tions in the past week.

Ev­ery­thing is up for re­assess­ment. “It will take time to gauge the global eco­nomic con­se­quences of Don­ald Trump’s sur­prise vic­tory,” JP Mor­gan’s chief global econ­o­mist Bruce Kas­man wrote in a note. “Forth­com­ing pol­icy changes are likely to gen­er­ate growth cross-cur­rents, but they should re­in­force the tilt to­ward global re­fla­tion.” Trump’s pro­pos­als rep­re­sent both a neg­a­tive sup­ply shock from curbs on trade and im­mi­gra­tion as well as a pos­i­tive de­mand shock from new fis­cal spend­ing, he added.

With the US econ­omy close to full em­ploy­ment - the job­less rate was 4.9 per­cent in Oc­to­ber - Trump’s elec­tion prom­ise to cut taxes and up­grade the coun­try’s age­ing in­fras­truc­ture could pro­vide a big boost to both growth and in­fla­tion. Of­fi­cial US data on Thurs­day will likely show con­sumer price in­dex in­fla­tion picked up slightly last month, up 0.4 per­cent on the month and 1.6 per­cent on the same month last year. Core in­fla­tion, which strips out food and en­ergy, is ex­pected to hit 2.2 per­cent. That fol­lows pre-elec­tion news of a pickup in av­er­age pay growth to 2.8 per­cent, the high­est since June 2009. Re­tail sales data due out on Tues­day are ex­pected to have lost a lit­tle steam last month.

In­fla­tion Ahoy

Sov­er­eign bond markets are al­ready out of the blocks in pric­ing in a rise in in­fla­tion ex­pec­ta­tions in the United States fol­lowed by the rest of the world. The 10-year US yield rose to 2.15 per­cent, al­most 30 ba­sis points above its lev­els around 1.86 per­cent just be­fore the US elec­tion on Tues­day. The surge has strength­ened the dol­lar against the euro and yen, which would ul­ti­mately help raise im­port costs in the euro zone and Ja­pan. If in­fla­tion moves higher from here, sup­ported by fis­cal stim­u­lus and ris­ing en­ergy prices, the cur­rent back-up in bond yields across the de­vel­oped world is set to con­tinue, pos­si­bly sug­gest­ing an end to a three-decade trend of fall­ing yields.

It is still early days, how­ever. Start­ing on Mon­day, it will be­come clearer how in­dus­tri­alised economies such as the euro zone, Ger­many, Italy, and Ja­pan fared in the third quar­ter - be­fore the US po­lit­i­cal earth­quake. Reuters polls show growth largely held steady in the euro zone de­spite a slow­down in Ger­many, and picked up slightly in Ja­pan. In­fla­tion was prob­a­bly 0.5 per­cent in Oc­to­ber in the euro area, sim­i­lar to a pre­lim­i­nary read­ing but above re­cent lows.

The grad­ual rise in in­fla­tion in re­cent months will be wel­come news for the Euro­pean Cen­tral Bank which, af­ter print­ing more than a tril­lion euros since March 2015 and cut­ting de­posit rates to -0.4 per­cent, is fast seen run­ning out of pol­icy tools. The ECB’s Gov­ern­ing Coun­cil next meets on Dec. 8 to de­cide pol­icy. Econ­o­mists ex­pect it to ex­tend its as­set pur­chase pro­gram beyond the planned end date of March 2017.

Yellen’s Fu­ture

A snap Reuters poll con­ducted in the 24 hours af­ter the US elec­tion re­sult in­di­cated no change at all in the ex­pected fu­ture path for the pol­icy rate. A series of Fed pol­i­cy­mak­ers are sched­uled to speak in the com­ing week and are likely to re­in­force the view that the fed funds rate will move up 25 ba­sis points to a range of 0.50-0.75 at the Dec 13-14 meet­ing. Cru­cial too for the rate tra­jec­tory is the fu­ture of Janet Yellen, ap­pointed by Pres­i­dent Obama as Fed Chair. A Reuters poll a few days ago found a ma­jor­ity of econ­o­mists ex­pect Yellen to serve out the re­main­der of her term un­til early 2018 but don’t think she will be reap­pointed.

“What is rel­a­tively clear is that there will be con­flicts be­tween a Trump ad­min­is­tra­tion and Fed Chair Janet Yellen af­ter Trump had se­verely at­tacked Yellen in his elec­tion cam­paign. The bridges be­tween both of them ap­pear to have been burnt,” Jorg Kramer, chief econ­o­mist at Com­merzbank, wrote to clients. Bri­tain’s Prime Min­is­ter Theresa May is sched­uled to travel to Berlin on Nov 18, a trip in which she pos­si­bly hopes to get pre­lim­i­nary talks un­der­way that would help the UK smoothly nav­i­gate the process of leav­ing the Euro­pean Union.

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