Focus may drift back to Fed and inflation

Trump victory poses major challenge

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.