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Donald Trump has won the US Presidential election. The Republicans also retained their majorities in both the House of Representatives and the Senate.
Trump’s election introduces significant uncertainty to the outlook for government policy, economic activity and the US Federal Reserve (Fed). Market volatility has spiked in reaction to the result and we expect this to continue over the coming weeks amid speculation about his likely policy agenda. However, we stress the importance of not overreacting and waiting for clear announcements of priorities.
Prioritising tax cuts and looser regulation
The president-elect and House Republicans have placed large tax cuts and corporate tax reform at the heart of their fiscal agenda. Mr Trump has also advocated a large increase in infrastructure spending. With Republicans also controlling the Senate, this implies a likely loosening of fiscal policy from late 2017 and into 2018, though fiscal conservatives in Congress may seek some offsetting cuts to other areas of discretionary spending. There is a strong prospect that the regulatory noose will loosen across finance, energy, telecoms and healthcare sectors.
Trade policy will be pivotal for the economy
At face value, the above policy agenda would boost economic activity over the next two years. However, Trump has pledged to increase trade protection and reduce immigration - policies that would simultaneously weaken economic growth and increase inflationary pressures. It is plausible that the new administration will not ramp up tariffs on Mexican and Chinese imports, content instead to bury the prospect of new trade agreements and make more use of enforcement clauses in existing agreements.
And the Fed...
Under that scenario there is a greater chance the Fed delays increasing US interest rates into 2017, awaiting more clarity on the market and policy outlook. However, once the noise dies down and it becomes clear that fiscal policy is set to become more expansionary, the Fed would likely recommence lifting its policy rate and at a faster pace than would have been the case should the Obama administration policies been maintained.
Should President Trump prove to be serious about pursuing a more protectionist policy agenda, the negative consequences for economic activity and corporate margins could easily offset the benefits of fiscal easing. This would prevent the Fed from increasing interest rates for some time. With particularly disruptive outcomes, the Fed may even consider easing policy. The subsequent effect on inflation expectations and unit labour costs would determine when and how much the Fed tightened once the turmoil subsided.
The election result initially caused markets to move to perceived safer environments, with bonds rallying and riskier investment types, including equities, declining substantially. The US dollar was broadly stable, as it generally fell against the major developed currencies and rose against emerging market currencies, especially the Mexican Peso.
However, the immediate reaction turned around on an expectation that President elect Trump and Republicans in full control of Congress would agree to push through a business friendly programme, for example infrastructure spending and tax cuts. Hence there has been a more positive tone to US assets, although concerns about Trump’s external programme – tariffs and migration controls – have caused emerging market currency to under-perform.
This volatile market mood could last several months. The longer-term implications for markets will depend on the actual policies of President Trump and what can be negotiated through Congress in 2017. His speeches and announcements about key individuals, such as the Treasury Secretary, will be seen as important markers this autumn.
At Standard Life Investments, we believe a number of positive and negative forces will influence how the dollar moves over the longer term: on the one hand Fed policy and any corporate repatriation of overseas cash, on the other hand the extent of tariff and migration changes. We expect government bond yields to be supported in the short term by strong central bank buying of global bonds, but how that will play out over the coming months will depend on the extent of changes to US fiscal policy, the implications for inflation expectations and the Fed’s response.
Once the initial volatility in equity markets subsides, we think lower corporate taxes and looser regulatory policies could provide a lift to corporate profits into 2017-18. However, any increase in the US dollar or higher interest rates would be influential for certain sectors. Stock picking remains important.
All in all, such an environment should create opportunities for investors focusing at a company level. Firms with extensive global exposure or those which are reliant on migrant labour would face a more uncertain future; firms that expected to face onerous regulatory requirements or could take advantage of higher government spending, say on defence or construction, might stand to benefit.
If the new administration begins to aggressively undo previous policies that have supported globalisation, it is likely we’ll see a hit to investor sentiment and therefore an extended period of weakness for risk investments such as equities.
Author: Standard Life Investment’s Global Strategy Team
16 August 2016
29 July 2016