PMC Weekly Review - December 9, 2016

A Macro View – What Next?

One month after the US election, investors continue to debate how President-elect Donald Trump’s policies will affect the economy and the markets. One week before the last Federal Reserve (Fed) meeting in 2016, we also wonder, how will the Fed react?

With regard to the former, President-elect Donald Trump’s pledges and policies that may affect the market include altering existing trade agreements, changing immigration, enacting tax reform, decreasing regulation, and investing in infrastructure. The first two are isolationist in nature (and could have negative implications), whereas the last three could stimulate economic growth.

Trump’s proposed tax reform includes a 35% tax cut on middle-class families with two children, and a decrease in business rates to 15% from 35%, which could stimulate both consumer spending and business investment. Decreased regulation, the possible repeal of the Dodd-Frank Act and lifting restrictions on energy production, could boost the Financial and Energy sectors, and infrastructure investments could exceed the proposed $1 Trillion in government spending. When calculating GDP by using the gross expenditure approach, if the decline in net exports is outweighed by the increase in consumption, investments, and government spending, GDP should rise, stimulating overall economic growth. In fact, Legg Mason stated that President-elect Donald Trump’s fiscal stimuli could add roughly 1.5% to GDP growth, and could increase US annual economic growth to 3%-3.5% next year alone.1 Overall, investors seem to agree that Trump’s pledges and policies will have a net positive effect: Stock market indexes rallied over the last month, with the S&P 500 Index gaining almost 4%.

Although the reactions of the economy and the markets to President-elect Donald Trump’s policies are yet to be seen, the Fed may need to change the speed of its course should the US find itself in an inflationary environment. Over the last few years interest rates remained depressed, and inflation stayed below 2%. In response, the Fed signaled slow and gradual increases in rates. But should the current strength in the economy be augmented by the aforementioned growth in GDP, inflation could rise, which could force the Fed to react by increasing rates faster than expected.

At this point in time, investors can only speculate on how the market and the economy will react to a Trump presidency. And, how the Fed will react. But, if climbing stock, bond yield and dollar prices are any indication, investors believe President-elect Donald Trump’s policies will be stimulatory. Said investors are keeping a close eye on inflation and the Fed to gain some level of understanding of future interest rates.

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