Financial Markets react to the US Presidential Elections

Pietro Mattarima

On November 8th, the United States elected Donald Trump as its 45th President. The election result was greatly unexpected, given that the vast majority of pollsters and analysts had predicted a Democratic victory. In the following days, financial professionals, initially caught off-guard by the outcome, scrambled to assess the effects of a Trump presidency.

 

Equity markets had a mixed reaction: stocks soared in the United States while they plunged in emerging markets. Mr. Trump had proposed slashing both the corporate and the individual income taxes. On expectations of higher corporate profits, the Dow Jones Industrial Average rallied to close at the all-time high of 18,869 on November 14th. Stocks in the pharmaceutical industry, battered by talks of a potential federal crackdown on high prices under a Clinton administration, jumped 8.9% the day after the election, on Mr. Trump’s more ambivalent attitude on the matter.

Emerging markets equities, especially in Latin America, experienced losses due to fears that the US might take a protectionist stance under Trump that will hurt their economies.

 

Bonds, usually overshadowed by equities, took center stage in the aftermath of the election. US interest rates on government securities increased on expectations of higher inflation in the future. Investors, seeking to lower their exposure to inflation, turned to Treasury inflation-protected bonds, sending up the yield premiums over regular Treasuries. The Federal Reserve has been watching these developments closely and derivative markets indicate that there is now an 86% chance of a December rate-rise, compared to 81% before in the week leading up to the election. The Fed would raise interest rates to keep inflation around its target of 2% year over year. The interest rate affected by a Fed’s decision is the Fed Funds rate, the rate at which banks borrow from one another.

Mr. Trump has pledged to adopt an expansionary fiscal policy, by lowering taxes and substantially increasing infrastructure investments. This is expected to result in stronger GDP growth, which also contributed to send rates higher. During periods of economic expansion, firms issue more bonds to finance their investments while demand for bonds increases more slowly, sending bond prices down and yields up.

Yields also soared in Europe: in the UK, 10-year gilt yields regained pre-Brexit levels and German 30-year bond prices are the lowest since May.

Overall, in the six days after the election, fixed income investors lost $1 trillion globally.

 

In currency markets, the US Dollar gained on all major foreign currencies on expectations of higher returns on US investments.

The election has also cast a shadow on the US M&A market, after the record frenzy of deals that took place last month. Chinese investors, responsible for over $70 billion of US acquisitions so far this year, have been advised by bankers and lawyers to hit the pause button until Mr. Trump clarifies his stance on cross-border deals.

 

Some analysts have expressed skepticism about the slump in bond prices and believe the market is overreacting to some of the promises made by Mr. Trump during his campaign. They argue that, given the uncertainty surrounding the President-Elect proposals, it would be more sensible to wait until more details emerge.

The real question now is on which of his proposals Mr. Trump will actually follow through. As a Morgan Stanley analyst put it: “Like Schrodinger’s cat, his policies existed in a state of being both pragmatic and radical, all at the same time”. Markets will look favorably at fiscal reforms that reduce excessive regulation, cut taxes, and increase infrastructure spending on projects with high social return, according to Joachim Fels, managing director and global economic advisor at PIMCO. On the other hand, they will negatively price in any strong focus on punitive tariffs and immigration bans. Overall, caution appears to be the most reasonable approach until the President-Elect assumes office on January 20th. In the meantime, unless meaningful new details emerge, rates are unlikely to go back to their previous level.

 

 

 

Sources:

http://www.wsj.com/articles/government-bond-sell-off-continues-on-trumps-economic-plans-1479114743

https://www.ft.com/content/c1ccbaa2-aa18-11e6-809d-c9f98a0cf216

https://www.ft.com/content/89749798-aa49-11e6-a0bb-97f42551dbf4

https://www.ft.com/content/48be04be-a9f9-11e6-809d-c9f98a0cf216

http://www.wsj.com/articles/gdp-inflation-and-interest-rates-forecast-to-rise-under-trump-presidency-1479054608

http://www.bloomberg.com/news/articles/2016-11-14/china-said-to-pump-the-brakes-on-u-s-dealmaking-after-trump-win

Image: wsj.com

Filed in: Economy

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