COMMENTARY
Macroscope
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Opinion: Trump’s hype on the economy simply sets the market up for a very bad fall

If he wants to reboot his presidency he needs to stop battling the press and judiciary, and get back to basics on the economy and jobs

PUBLISHED : Monday, 22 May, 2017, 8:38am
UPDATED : Monday, 22 May, 2017, 10:37pm

It is safe to say the great reflation trade is fast running out of rope. The market rally fuelled by hopes that US President Donald Trump would inject a new lease of life into the global economic recovery has suffered a lethal blow.

As the poster boy of US economic revival and reform, the deadly political firestorm swirling around Trump’s presidency threatens to engulf global well-being.

While it may be too soon to start writing Trump’s political obituary just yet, the outlook is not looking good. The furore is far from over and political pressure is building on the US administration. If Trump’s days are numbered as an effective president then it will be hard on markets. After all, equity rallies are all about confidence and, if the political mood sours much more, markets are in for a bad shock.

The US equity rally has come a long way in recent months, but it is a trade that has become increasingly overcrowded, with markets starting to fret about valuation constraints

The risk of impeachment may be a long way off, but there could be considerable damage along the way. The worry for markets is all the cut and thrust of Trump’s main economic agenda and reform plans will be blunted as the Administration’s energies go into fighting raging bush-fires.

The last thing the US economy needs is a lame duck presidency, collapsing into a heap of forgettable mediocrity.

The US equity rally has come a long way in recent months, but it is a trade that has become increasingly overcrowded, with markets starting to fret about valuation constraints. Market momentum needs a major reboot, but reasons for optimism remain dangerously thin on the ground right now.

The good news is that world financial markets are still basking in the warm afterglow of the great monetary stimulus, engineered by the world’s central banks after 2008 to fend off the global crash.

Interest rates set close to zero and the flood of new money created by quantitative easing saved the world economy’s skin and helped prop up financial markets when complete collapse threatened.

The bad news is that markets have become much too dependent on the free and easy ride, leaving a ‘bubble’ mentality in its wake. When markets become detached from underlying fundamentals, the odds of a subsequent crash escalate very sharply. This was the fate of the US dotcom boom back in 2000, when excessive investor speculation and irrational exuberance finally collided with economic reality.

The six-trillion-dollar question is whether the markets are bigger than “the man” in the long run. Sure, the markets are banking on Trump delivering the goods on tax cuts, supply side reforms and major infrastructure spending, but the promise of a doubling in future US gross domestic product growth to 4 per cent is a bridge too far in terms of reasonable expectations.

In the long run, markets should transcend the upcoming crisis, but a stiff, short term equity correction may be necessary to recalibrate expectations to what is realistically achievable.

The markets are banking on Trump delivering the goods on tax cuts, supply side reforms and major infrastructure spending, but the promise of a doubling US gross domestic product growth to 4 per cent is a bridge too far in terms of reasonable expectations

On the plus side, the US economy is still making positive progress, with capital-intensive, productivity-driven growth providing the powerhouse for the US blue-chip corporate-sector renaissance and the booming labour market, too.

There are still potential weak spots in the economy, not least the US’ overdependence on consumer spending and the vulnerability of the housing market, but they are still providing vital mainstay support for the recovery right now.

Consumer confidence is running close to multi-year highs despite Trump’s troubles and needs very careful nurturing in the Federal Reserve’s future policy tightening plans.

As long as the Fed strikes the right balance between its growth and inflation objectives, it should keep markets on an even keel.

Maintaining future economic growth in a 2 to 3 per cent band while keeping inflation stable around 2 per cent should set the bar high enough for US equity markets to extend plausible and sustainable gains ahead.

What the market needs right now is straightforward honesty and credible targets. Overegging US growth expectations up to 4 per cent and promising the earth in terms of bringing back jobs to America’s dispossessed rust-belts is doing nobody any favours. Trump’s hype on the economy simply sets the market up for a very bad fall.

If Trump wants to reboot his presidency he needs to stop battling the press and judiciary and get back to basics on the economy and jobs, but only working within believable parameters.

Credibility is the key going forward. If Trump fails, he not only imperils his own presidency, but also risks sinking equity markets in the process.

David Brown is chief executive of New View Economics

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