Can the Trump Administration Make the American Economy Great Again?
Trump’s tax and infrastructure proposals will soon face the reality of US debt and monetary policy. We analyze what to expect next.
Since the US election, financial markets seem to have priced in a significant boost to growth and inflation under a Trump administration. It is still early in the presidential transition, yet the US equity markets have rallied and bonds have sold off in an apparent anticipation of major fiscal policy easing and deregulation under soon-to-be President Trump. The Trump campaign was generally unspecific about its favored policies in most areas, and it also remains unclear which policies will actually materialize. However, we attempt to delve into President-elect Trump’s proposed policy agenda, acknowledging that uncertainty remains high.
Crunching the numbers on taxes and infrastructure
Based on the two most substantial Trump fiscal initiatives as they have been communicated so far — tax reform and infrastructure spending — Invesco Fixed Income has estimated how they might impact economic growth going forward. The Tax Policy Center estimates that the tax plan alone may increase fiscal spending by around $7 trillion over the next 10 years.1 Infrastructure spending is likely to be a smaller amount. We estimate that the impact of this spending may be to boost gross domestic product (GDP) growth from around 2% currently to around 5% over the short term, under optimistic assumptions.
In our view, however, it is very unlikely that this level of planned fiscal spending will be achieved. Current levels of debt are likely to constrain these spending plans. For example, in the early 1980s, when President Ronald Reagan passed his tax reform, government debt held by the public as a percent of gross domestic product (debt-to-GDP) was around 25%.2 In 2001, when President George W. Bush’s tax cuts were passed, debt-to-GDP was around 30% and projected to fall.3 Current debt-to-GDP is 75% and projected to rise for the foreseeable future.4 While the bond market may likely have little problem financing this level of debt expansion, in our view, the fiscally hawkish segment of the Republican Party may not back it. This means that President-elect Trump could face more limited scope for fiscal expansion than past presidents had.
We think a reasonable estimate for what President-elect Trump will likely be able to achieve is closer to around 25% of his proposed fiscal easing. This may amount to around $150 billion in stimulus spending per year over the next 10 years, according to our estimates. Under reasonable assumptions, we estimate that this spending may boost GDP growth by around 0.5% per year in the near term, all else equal. This may still be a fairly significant boost relative to our trend GDP forecast of 1.75%.
Monetary policy response
An important factor in determining the ultimate impact of economic policy changes is the response of monetary policy. Because the US is already close to full employment, the US Federal Reserve (Fed) could raise interest rates more than the expected two hikes to offset fiscal stimulus if it thought the economy was in danger of overheating. If we begin to see increased growth and inflation, the markets may price in a faster pace of Fed tightening, pressuring interest rates up. This could have a direct impact on money market rates, pushing them up higher than most investors currently expect. With Fed Chair Janet Yellen’s term set to expire in February 2018, markets may begin anticipating her successor’s policies as soon as mid-2017. If interest rates drift up and/or markets expect a more hawkish policy stance post-Yellen, this could reduce the effectiveness of fiscal spending and complicate the economic outlook.
We believe there are two key areas to watch in 2017 that will determine performance of risk assets, such as credit assets: Trump’s success in pushing through his fiscal policies along with Fed dynamics. Even if President-elect Trump achieves more than our base case of a $150 billion per year increase in spending over the next 10 years, the Fed may step in to prevent the economy from overheating, which could reduce the overall impact on growth.
1 Source: Tax Policy Center, Oct. 18, 2016
2 Source: Federal Reserve Economic Data, Dec. 31, 1980
3 Source: Federal Reserve Economic Data, Dec. 31, 2001
4 Source: Federal Reserve Economic Data, Dec. 31, 2016
Source for all other data: Invesco Fixed Income as of Jan. 9, 2017
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James Ong, CFA
Senior Macro Strategist
Derivative Portfolio Manager
James Ong is a Senior Macro Strategist and a Derivative Portfolio Manager for Invesco Fixed Income (IFI). Mr. Ong contributes economic and market analysis to the Macro Research platform. Mr. Ong leads IFI derivative strategy and oversees derivatives held in IFI portfolios.
Mr. Ong began his investment career in 2001. Prior to joining Invesco in 2014, he was a senior vice president, a senior portfolio manager and a senior trader at Hartford Investment Management Company.
Mr. Ong earned his BA degree in economics from Middlebury College. He is a CFA charterholder.
Noelle Corum, CFA
Invesco Fixed Income
Noelle Corum joined Invesco Fixed Income in August of 2010 and is involved in derivatives, FX and rates trading, macro view implementation and asset allocation.
Ms. Corum began her investment professional career at Invesco following her undergraduate studies.
She earned a BS degree in business administration, with a concentration in financial analysis, from Saint Louis University, where she minored in mathematics and earned a certificate in service leadership.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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