Twice in five months, the people have spoken and President Trump is heading for the White House. We won’t get into the politics here because we are fixed interest experts, not Fox News, but we will focus on the economy and what it all means for us as Australian income seeking investors
That’s all, “folks”. The American people have spoken and President Trump is heading for the White House. The election result won’t dramatically change the trajectory of the US economy, but it will cause shockwaves through global financial markets.
In financial markets, the risk off trade is well under way. Gold is up, all other commodities are down; bonds are also up, as equities fall. The USD is down, but emerging market currencies and the AUD have fallen even harder. The impact on Australian investors depends upon your portfolio, however the ASX was off 2.1% at the time of writing and the banks were particularly hard hit. But holders of bonds and foreign currency (except Pesos) profited.
This year will go down as the western world’s version of the Arab Spring social uprisings that rocked the Middle East in 2010/11. Far less violent, but nonetheless impactful. High structural unemployment from the shifting of manufacturing jobs to emerging markets, followed by the GFC that ultimately hurt working families more than financial markets, has led to a strong push back against globalisation. It also led to anti immigration, with migrants wearing a lot of the blame for the challenges families have faced.
Donald Trump has successfully immobilised that frustration – and now will have some opportunity to try to make a difference to their lives. Two questions face Australian investors then:
- What will a Trump presidency do to the economic trajectory in the US?
- What does a Trump presidency mean for the rest of the world?
The US economy remains one of the two most important factors in Australian investors’ likely returns and risks over the coming decade; China’s economic health is the other. The good news is the US economic recovery is on track and strengthening, while the rest of the world struggles to maintain momentum without extreme stimulus. The EU and Japan have managed very mediocre results, despite massive monetary stimulus. China’s GDP is holding up, but only thanks to one of the most extreme increases in economy wide leveraging in modern history.
That sums up the most likely impact that a Trump presidency will bring to the global economy – his policies of more for the US and less for the world come at a perilous time for global markets and the real economy. Of course his victory on the back of the Brexit vote and similar anti globalisation, anti immigration movements across Europe will only encourage more political and economic unrest in coming years.
For Australia, this is certainly not good news. Our way of life is not going to be threatened, nor will the economy scream into a recession. But if Trump is able to achieve half of his trade policy changes – such as ending the Trans Pacific Partnership (TPP) or putting pressure on China’s steel industry – it will directly impact our exporters, particularly iron ore exporters. Sadly, the largest victim of our favour toward the Chinese over the past decade has been a massive reduction in our exports to the US. That will come back to hurt us under a Trump administration.
The rest of this article is split into two sections: a brief recap from our earlier WIRE article on what changes President Trump will actually be able to make, and a snapshot on the state of the global economy, using employment as a lens to show which economies are the most vulnerable.
Can impact will Trump have on the US and global economy, if any?
Trump will likely enjoy a senate and Congress majority. Not all Republicans will support all of his policies, but he has a better chance of instituting change than Clinton would have.
Trump’s biggest impact on the US economy will be
- Tax cuts for households, particularly middle and upper middle class
- Tax cuts for business
- Likely lower business investment in the next 12 months
- Increased fiscal pressures, higher debt and potential for a downgrading of the US’ credit rating
- Some risk of inflation on goods, depending upon how extreme his trade policy changes are by the time they pass through both houses
- Beneficial – at least in the near term – for jobs growth in the US, albeit with heightened inflation risk offsetting that benefit
Trump’s impact on the global economy
- Most of it comes down to how extreme his trade policies are, once passed through Congress and the Senate. The TPP (Trans Pacific Partnership, a trade agreement that would have been mildly beneficial to the Australian economy) will almost certainly be axed, or at the very least made far more favourable to the US.
- In the longer term, Trump’s ability to dent the US’ favoured nation status for the world’s middle to upper class migrants will be limited. He may have some impact on Mexican immigration, but even then the budget costs of additional policing of borders (or a huge wall!) must pass through Congress before Trump can have an impact.
Trump’s impact on Australia
The axing or renegotiating of the TPP is a negative for Australia in terms of direct trade with the US, but it will also impact exports from Asia to the US – some of which is manufactured with Australian commodities
- Regional political instability could rise if Trump follows through on his threat to remove US military from Japan and Korea. Any military action amongst Australia’s key trading partners is strongly negative for Australian companies
US jobs growth continues to be strong, with wage growth at its highest level since the recession
This result is stronger than we’ve seen from the US – or any other major economy – since 2007. The two weakest points remaining for the US employment market is the number of underemployed and the rising number of long term employed.
The table below shows various ways of measuring the health of an economy based on its employment conditions. Of these measures, underemployment, real wage growth and hours per available worker are the best indicators of economic health in the short to medium term. Long term unemployment and youth unemployment are indicators of longer term economic health and social issues.
Figure 1 – employment scorecard
| US | UK | Japan | Australia | EU |
Unemployment
(compared to pre GFC levels) | 4.9%
(5.5%) | 4.9%
(5.5%) | 3.0%
(4.0%) | 5.6%
(5.7%) | 10.0%
(8.8%) |
Underemployment
(compared to pre GFC levels)
| 9.5%
(8.9%) | 10.5%
(10.2%) | 6.1%
(5.0%) | 14.2%
(10.2%) | 14.6%
(12.8%) |
Hours worked vs 2007
| Flat | Flat | Down 3.8% | Down 3.0% | Down 2.9% |
| Real wage growth vs 2007 | Up 7.5%, trending up at near historic average | Down 2.0%, but trending up slowly | Up 1.2%, trending up very slowly | Up 5.1%, but trending down since 2013 | Up 2.5%, trending up but at slowest global pace |
Long term unemployed vs 2007
(% of unemployed out of work for 12mths+)
| Up from 11% to 18%
| Up from 29% to 32%
| Up at 40% vs 45%
| Up from 16% to 25%
| Up from 41% to 50%
|
Youth unemployment
| Flat at 10%
| Flat at 13%
| Down from 8% to 7%
| Up from 10% to 12%
| Up from 16% to 20%
|
Overall "score"
| 6.6 | 4.5 | 3.8 | 3.8 | 2.9 |
Source: ABS, Eurostat, FRED, Japan Ministry of Internal Affairs and Communication, OECD, UK Office of National Statistics and the US Bureau of Labor Statistics We can conclude that the US economy, based on these metrics, has a far stronger outlook than its global peers and Australia. This creates a base case scenario in which US interest rates and the USD will face upside pressures in the coming years.
In more detail:
- The US economy continues to show stronger recovery than most of the rest of the western world
- Unemployment is below historic averages, but underemployment is still above. In other words, there are still a lot of people in part time jobs that want full time jobs
- Wage growth is at a nine year high, but still below historic averages. The same applies to average hours worked
- Long term and youth unemployment are back to pre GFC averages
- Of the comparison countries, only the UK comes close
- All countries have underemployment well above long term averages and real wage growth below, showing that the global economy is still recovering slowly
- US and UK are the only countries where hours worked is above 2007 levels. This typically indicates they have managed to maintain or improve the ratio of full time to part time/unemployed workers – a measure of the demand for labour
- However, real wages in the UK fell so heavily in the early years of the recession that they still haven’t fully recovered despite recent strength. Also, the UK has more long term unemployed than in 2007, and Brexit will only worsen this if it impacts the manufacturing sector further
- The EU scores poorly on every measure, with Germany the only notable exception. While not noted above, Germany is up on almost all measures, leading to further disunity in the EU
- Japan’s results are slightly better than the EU, but only due to demographic differences, namely that they simply have less youth
- Australia’s scorecard is mixed, but mostly sits with the EU and Japan based on recent results. Wage growth, hours per worker and the long term unemployed are moving sharply in the wrong direction. The apparent jump in Australia’s youth unemployment is not as serious as it seems, simply because the 2007 figure was a record low
- Outlook for US rates. Overall the recovery remains on track, but its strength will be tested by higher interest rates. This reinforces the point that the Federal Reserve must be patient. If they increase rates too quickly the recovery could stall, particularly if Europe and Japan remain depressed.
Conclusion
Based on the health of the employment market and the flow on impact that wages has on inflation, US rates are likely to rise. This is followed by another 0.5%pa in 2017, and is likely to gradually rise back to 2.0% to 2.5%pa. Just how slow that rise is depends on the global economies like the EU, Japan and China, as it does domestic conditions. If the Fed were to use Trump’s victory as an excuse to hold off a rate rise, they would lose credibility – which is important for them to maintain some control over the economy.
Trump’s victory means that 2017’s increases probably favour just 0.25%, depending on his impact on inflation risk. This isn’t likely to happen so quickly, so the Trump win means a more likely scenario is a 0.25% increase in 2017, followed by 0.5% increase in 2018 assuming the economy continues to strengthen. Any inflationary impact of his trade policies will show up in 2018, meaning that there is a risk of an additional 0.25% to 0.50% in that year. However, this remains an outside risk due to the watering down of his policies through the political process.
Without any Trump induced inflation, US rates are on track for gradual 0.25% to 0.5% increases each year for the next three to four years, but that is dependent on how the rest of the world recovers. The US cannot afford for their rates to rise too much ahead of their major trade competitors or the USD will rise too sharply and damage the domestic economy.
Regardless, the outlook for the USD remains strong, as the pressure on US rates to rise will be so much greater than in other economies including Australia.
One final word on the risk off trade
As of last night, speculators had a strong position in the AUD, the highest position they have been since just before the sudden drop in the AUD in mid 2014. If the “risk off” trade continues, we could see speculators exit and cause a sharp correction in the AUD:USD exchange rate.
Trade ideas
- Gold miners’ corporate bonds, particularly in the BB/BBB range where there is good income, but not too much volatility. See this article
on gold bonds for more information - Infrastructure, avoiding US health sector, but remembering that the Trump administration is likely to be in favour of corporatizing government services and in favour of building more infrastructure. Any companies linked to US infrastructure services or construction will also do well from the Trump administration
- Inflation and duration risk. More challenging to predict, but some of Trump’s policies could create inflation, particularly for durable goods that would otherwise have been imported from China or clothes from Mexico. While this will have minimal impact on inflation in the rest of the world, investors should seek to take profits on longer dated USD corporate bonds where opportunities rise, and shift that into either shorter dated corporates, or the gold or infrastructure trades above
- Long dated Australian corporate debt. On the flipside to the above, negative consequences for Australia from the Trump stance on trade, and the threat to the global economy, is likely to put downward pressure on Australian yields. Investors could look to set longer dated positions to take advantage of this.