By James Mackintosh
Markets are clear about what Donald Trump plans for his return to the White House: Stock futures are up, the dollar and Treasury yields are soaring, and so are banks and bitcoin.
All are easy to fit to Trump's promises. Corporate tax cuts almost automatically boost stocks, tariffs almost automatically mean a stronger currency, bigger deficits mean higher bond yields and easier regulation helps bank stocks and bitcoin.
Whether this knee-jerk reaction proves right in the longer run is another matter.
The first issue is the remaining uncertainty about the House election, where we will find out whether Republicans will have the majority to push Trump's agenda.
Without the majority to push through tax cuts or the ability to raise spending, the deficit would be improved by his promised hike in tariffs, which amounts to a large tax rise. This would throw into question the logic of the rise in Treasury yields.
The 30-year yield has risen the most in a year. It is an indication that the out-of-control deficits run by both President Biden and Trump will continue indefinitely.
The second issue is the impact on the economy of Trump's two leading policies, immigration and tariffs. If he follows through on the promise to deport millions of immigrants who entered the country illegally, it would be a major supply shock, reversing one of the issues that has helped to cool the jobs market and reassured the Federal Reserve that inflation is back under control.
Supply shocks mean higher inflation and slower growth, and are typically bad for stocks. Any hint of renewed inflation worries would push up bond yields, again bad for stocks.
The promised rise in tariffs has a textbook effect, boosting the dollar. Foreign currencies have to adjust down so that prices in dollar terms remain about the same after tariffs, exactly what happened in 2018 when Trump raised tariffs on China. If he goes ahead with across-the-board tariffs -- plus 60% on China and special higher levels on Mexican car imports -- the dollar should get a bigger boost.
Traders are on top of this, with the dollar up 2.7% against the Mexican peso and 1.7% against the euro. In futures they are also betting big on smaller companies, which tend to be more domestically focused and so less hit by tariffs, with Russell 2000 futures up 4.5%, double the gain for the S&P 500.
The effect on the currency could be partially offset by tariffs on U.S. exports and by the potential for a full-blown trade war of escalating import taxes. The rest of the world would be bigger losers from this than the U.S. This is because the U.S. runs a big trade deficit and because its exports are led by oil and aircraft parts, neither of which are likely to be targeted by other countries.
While the U.S. might be hit less badly than other countries if there's a trade war, it would still be hit. Slower growth in the U.S. ought in principle to hold back stocks and hold down Treasury yields -- again, the opposite of the market's assumption.
The third issue that will determine the fate of the Trump trade: the starting point. Back in 2016 stocks were much cheaper, with the S&P 500 at 16 times forecast earnings. The S&P is now at 22 times forecast earnings, so a lot of good news is already in the price. Likewise, the 10-year Treasury yield is at 4.4%, against 1.8% in 2016, and the ICE U.S. dollar index is at 105, against 97. It was easier in 2016 for all three to rise, so any disappointment about the direction or speed of Trump's policies would hurt.
This leads into the fourth issue, history. Traders called Trump entirely wrong at least twice in 2016. The immediate reaction to his surprise win was a massive selloff in stock futures, which were limit-down, off 5%, overnight -- exactly the wrong move. Bond yields and the dollar then soared for the rest of November and December as investors prepared for him to take office in January -- before the dollar plunged for all of 2017, and Treasury yields and what were then regarded as "Trump trades" in the stock market pulled back.
Investors believe they have a handle on what Trump will do this time. But it's not obvious that they are any better at assessing politics, or that Trump himself is any more predictable.
Write to James Mackintosh at james.mackintosh@wsj.com
(END) Dow Jones Newswires
November 06, 2024 05:36 ET (10:36 GMT)
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