Trump tantrums: Asian investors should brace themselves for a wild ride in the market
Andrew Sheng expects considerable volatility, and even if the US economy improves, trade is unlikely to benefit
In the lead-up to January 20, 2017, when Donald Trump assumes the US presidency, Asians are all guessing about the outlook for their savings. Trump is particularly difficult to read because he has made so many wild statements during the campaign trail. Everyone accepts that campaigners promise heaven and deliver mostly hell. Generally, candidates become more sober after they win the vote.
So far, however, it looks like Trump’s policies will follow his campaign threats.
The Trump presidency will be bipolar – either highly successful if he reboots American dynamism, or he may bankrupt the country trying.
Wild swings in investor mood can be read from the way the markets have yo-yoed from hesitation to rally. So far, Trump’s family members appear to have more clout with the incoming president than is the case with any previous president.
Disappointingly, if the Treasury secretary is another ex-Goldman Sachs man, Wall Street is likely to have another insider running the status quo. It remains to be seen whether the new secretary can manage simultaneously the promised spending on infrastructure, cutting taxes for the rich and containing the effects of a stronger dollar.
All signs are that the dollar will become stronger, recalling the famous phrase – “my dollar, your problem”. The latest IMF health check on the US economy, published in June, said the US dollar is assessed to be overvalued by 10-20 per cent and the current account deficit is around 1.5-2 per cent “larger than the level implied by medium-term fundamentals and desirable policies”. The International Monetary Fund thinks that the risk of a dollar surge in value is high, with a 10 per cent appreciation reducing gross domestic product by 0.5 per cent in the first year and 0.5-0.8 per cent in the second year.
Trump is likely to be highly expansionary in his first year because the Republicans, having control of the Congress, Senate and presidency, must demonstrate that they will revive growth and jobs to ensure a second term. Note that Trump’s election promises of stopping immigration, scrapping the Trans-Pacific Partnership, imposing sanctions on China and cancelling the North American Free Trade Agreement are all inflationary in nature.
This is why, if the Federal Reserve does not raise interest rates in December, it may be under pressure next year not to take any action to slow a Trump economic recovery. Independence of the Fed will be called into question, since Trump’s expansionary policy will put pressure on his budget deficit and national debt, already running at 3 per cent and 76 per cent of GDP respectively. A 1 per cent increase in nominal interest rates would add roughly 0.7 per cent to the fiscal deficit, making it unsustainable in the long run.
Those who think that the recovery in US growth would be good for trade are likely to be disappointed. So far, the US recovery (which is stronger than either Europe’s or Japan’s) had not led to much increase in imports, due to three effects – lower oil prices, the increase in domestic shale oil production and more onshoring of manufacturing. The US current account deficit may worsen somewhat, to around 4 per cent of GDP, and this will not improve unless sanctions are imposed on both China and Mexico, which will in turn hurt global trade.
Why is a strong dollar risky for the global economy? The answer is that the global growth model would be too dependent on the US, while the other economies are still struggling. Europe used to be broadly balanced in terms of current account, but has moved to become a major surplus zone of around 3.4 per cent of GDP as a whole. Germany alone is running a current account surplus of 8.6 per cent of GDP in 2015.
Japan has moved back again to a current surplus of 3.7 per cent of GDP, but the yen remains weak against the dollar. I interpret the Bank of Japan’s qualitative and quantitative easing as both a tool to boost financial stability and an attempt to ensure that the capital outflows by Japanese funds would outweigh the inflows from foreigners punting a yen appreciation. The Bank of Japan’s unlimited buying of Japanese government bonds at fixed rates would put a cap on losses for pension and insurance funds holding long-term bonds if the yield curve were to steepen. Japanese pension and insurance funds have been large investors in US Treasuries and securities for the higher yield and possible currency appreciation.
In short, the capital outflow from Japan to the dollar is helpful to US-Japan relations. Prime Minister Shinzo Abe, being the first foreign leader to call on Trump, is dangling a carrot that Japan can fund Trump’s expansionary policies, so long as Japan is allowed to rearm.
From June 2007 to June 2015, US Treasury data showed that the total amount of US securities held by foreigners increased by US$7.3 trillion to US$17.1 trillion, bringing its gross amount to 94 per cent of GDP. Japan already holds just under US$2 trillion of US securities and, as a surplus saver, has lots of room to buy more.
The bottom line for Asia is not to expect great trade recovery from any US expansion. On the other hand, Asian investors will continue to buy US dollars on the back of the prospect of higher interest rates and better recovery. This puts pressure on Asian exchange rates.
Of course, it is possible that the US fund managers will start investing back in Asia, but with trade sanctions and frosty relations between China and the US in the short term, American investors will stay at home. If interest rates do go up in Asia in response to Fed rate increases, don’t expect the bond markets to improve. The equity outlook would depend on individual country responses to these global uncertainty threats.
In short, expect more Trump tantrums in financial markets.
Andrew Sheng comments on global issues from an Asian perspective