Time to Pay Attention to 'Trumpflation'

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Indexes hit record highs
For some time, conventional wisdom held that the financial markets would be more comfortable with Hillary Clinton than Donald Trump as the next US president. True to form, on election night, many major indices fell along with Clinton's chances as the results rolled in. Surprisingly, however, once the election's results became clear the next day, markets re-priced quickly, seemingly happy to anticipate a future US economy with Donald Trump at the helm. Since then, burgeoning optimism has driven the large-cap S&P 500 Index, the small-cap Russell 2000 Index and the US dollar to their highest levels since at least March 2003.

Among the forces underpinning the shift is the growing likelihood of rising US inflation: Since the November 8 vote, investors have piled on bets that inflation will pop. The 5-year/5-year breakeven rate—the market-implied average for inflation between 2021 and 2026—is up from just 1.4% in July to more than 2%, the highest level in more than a year. As a result, bond yields rose violently as prices fell during a widespread bond selloff—not just in the US, but in much of the world. In the futures market, the odds of a Fed rate hike are surging, as prospectively higher inflation translates into faster Fed tightening.

It is worth clarifying that higher inflation is not necessarily a "bad" thing for the US or any other economy—especially if inflation is the result of higher growth, and provided that the economy's central bank is able to hold inflation at a healthy level without letting it get too low or high.

The root causes of 'Trumpflation'
There are three primary reasons why Trump's proposed policies, if enacted, could soon begin pushing inflation higher:

  • During his campaign, Trump announced plans for big tax cuts, less regulation and more public spending—initiatives that should foster faster growth and pressure prices.
  • On the trade front, Trump's proposals to slap tariffs on Chinese goods and renegotiate NAFTA would mean higher import costs for US consumers and businesses.
  • Tighter immigration standards and deportations would generate wage inflation in industries ranging from technology to construction and agriculture.

The economic pros and cons of Trump's proposals
One can find compelling reasons for Trump to focus on his proposed, inflationary path. For instance, America's 39% corporate tax rate is the highest in the developed world, and onerous regulations are a perennial complaint among small business owners—the people who employ the bulk of the workforce. From a public spending standpoint, there is also scope for expansion: the US government accounted for just 17% of GDP last quarter, the lowest level on record. In addition, America's trade deficit ballooned from -0.3% of GDP in 1992 to -2.5% today.

At the same time, there are also compelling arguments to be made against Trump's proposals. US debt is at a record high and appears set to move higher, which is why Trump's deficit-financed fiscal splurge will be challenged by many legislators—including conservative Republicans in his own party. Moreover, the "Trump Tantrum" in bond yields could dampen growth; indeed, home mortgage refinancing is already sagging. Meanwhile, the recent run-up in the US dollar is disinflationary for commodities and import prices, which suggests that the markets could be overshooting their assessment of inflation expectations.

Trump won the presidency by rallying support across America's "Rust Belt", yet like other elements of his agenda, bringing back factory jobs displaced by technological advances could prove tough. Time will tell if Trump's policies bring back the right level of inflation as well.

Will Mortgage Refinancing Continue Sliding Under Trump?
Despite low mortgage rates, refinancing activity was already falling—and it could get worse if rates keep rising due to a "Trump Tantrum" selloff in US Treasuries.

Source: FactSet as of 11/18/16 (mortgage rates as of 9/30/16).

Important Information
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

The Russell Top 200 Value Index measures the performance of the 200 largest companies in the Russell 1000 Index with lower price-to-book ratios and lower forecasted growth values. The Standard & Poor’s 500 Composite Index (S&P 500) is an unmanaged index that is generally representative of the U.S. stock market. Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. It is not possible to invest directly in an index.

Allianz Global Investors Distributors LLC, 1633 Broadway, New York, NY 10019-7585, us.allianzgi.com, 1-800-926-4456.


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© Allianz Global Investors

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