11 Nov 2016 Mr. Trump’s Mandate and Agenda
Whether or not President-elect Donald Trump has a mandate to pursue the huge changes he aspires to make is a matter of debate. He won impressively from an electoral standpoint, but the popular vote looks razor-close. What is practically inarguable is the fact that the block of voters who elected him is more unified, emboldened, resolute, and stable than any voting block in recent political history. The populist movement that put him where he is today is not going away, and they are watching. He knows it, a divided Republican Party knows it and a reeling Democratic Party knows it.
All this is to say, that if Mr. Trump chooses those issues on his list that resonate well with both his base and a diverse Congress, he will likely get meaningful legislation passed quickly. Let’s take a look at a few of these actions most likely to have early fundamental impact on the the economy.
As you have heard us say over and over, the bond market provides the best gauge for both short and long-term economic activity, inflation, and interest rates. Given the importance of each of these concepts to describing what is going on now with our economy, our budgets and our financial decisions, perhaps a basic explanation of how they all work together will be helpful.
Bonds are like other fixed income assets, such as CD’s and annuities, in that their interest rate and holding period (maturity date) are fixed. They vary, however, in that they are traded on exchanges, so their prices fluctuate. If you own a bond that pays 2% and rates rise to 3% for a bond with the same maturity, your 2% bond becomes worth less because it’s return of 2% has diminished relative to current bonds at 3%. But you are still guaranteed to get 100% of your principal back when it matures, making bonds safer than stocks, which have no such guarantee.
Bond markets set interest rates indirectly by monitoring inflation trends (a measure of price changes in goods and services). When economic activity accelerates, it can cause business demand to outstrip supply for things like like labor, raw materials, and plant capacity. And from basic economics we know that when demand exceeds supply, prices rise. Businesses pay more for the products and services they produce and pass them along to consumers if they can. As all of these prices begin rising, demand for cash from businesses and consumers begins to outstrip the supply of cash in the economy and the price of money, known as interest rates begins to rise.
The bond market is a far better barometer of economic expectations than is the stock market, because of the long holding periods. Bond buyers lock their returns up for a considerable number of years, so it is very important for them to understand what inflation trends might be going forward. Inflation is the worst enemy of bondholders because as prices rise, their income remains, well – ‘fixed.’
In the last few days there have been two significant drivers moving the bond markets. The Federal Reserve and Donald Trump. The Fed is now tasked with unwinding its unprecedented policy of easy money to support the economy before it begins growing at rates faster than it has in the past few years. They will do this by raising the interest rates they charge to banks for money (and of course banks pass the increase along to borrowers at the speed of light). They will also sell of some of their huge trove of US Treasury Bonds. The impact of the latter soaks up cash from the economy as bond buyers trade cash for securities. Finally, as the Fed sells large number of Treasuries, excess supply of bonds on the market drives prices lower, and rates up. Remember, lower bond prices mean higher interest rates.
The surprise election of Mr. Trump has added to the sell-down of government bonds in the last few days. The assumption is that Mr. Trump’s policies of cutting taxes and increasing government spending for infrastructure will be inflationary. According to the WSJ, the yield on the benchmark 10-year US Treasury note climbed to 2.118% from 2.070% Wednesday. That came on the back of the biggest one-day jump in the 10-year yield in over three years Wednesday. Our IEF, 7-10 Year US Treasury Index is down 2.3% since the election.
We own Treasurys in our client portfolios not for investment return and growth (stocks do that), rather we own them for portfolio protection. Treasurys usually rise when stocks are falling on fears of economic decline. A portfolio heavy in stocks will swing wildly. Large swings can scare investors from the stock market, diminishing even eliminating its huge long-term growth potential, and large swings reduce the statistical confidence of a long-term financial plan. Read more about why we own Treasurys even when they may be declining in value as well as another piece that takes a broader look at the reason for Treasurys in portfolios.
The worst fears of inflation will likely not be realized by Mr. Trump’s policies because Congress, while working with him, will likely keep a tight grip on spending. Paul Ryan leads a very conservative coalition in the House and Mitch McConnell a more moderate one in the Senate. In order for Mr. Trump to pass meaningful legislation he will need to find the right balance among House conservatives and moderate Republicans and Democrats in the Senate. The fact that Mr. Trump’s very passionate power base will be looking over all of their shoulders is not lost on anybody at this point as the legislative agenda is being sequenced.
Some of President-elect Trump’s early legislative moves that may have significant bipartisan support and early economic impact will be infrastructure spending on roads, bridges, airports, the electric grid, the Internet, and other vital infrastructure. To a lesser extent, the military will also factor large in early legislation, perhaps ending the steadily draining impact it has suffered at the hands of sequestration. Republicans will likely tie tax reform to these bills as they move into what is a popular part of the Democratic agenda.
The energy sector will create thousands of jobs as hurdles to pipeline construction will be lifted and climate change rules rolled back. Oil and gas production will be allowed to expand into resource-rich areas previously restricted, such as federal lands and others. To achieve requisite Democratic support for these measures, Trump and Republicans will have to find balance among environmental and economic impact. But with current majorities, its likely the scales will favor the economy.
Mr. Trump has said he will eliminate many of Mr. Obama’s executive orders he views as drags on business and the economy. He can do so without Congressional action, if he so chooses for expediency, though it would be a show of good faith to include them in the process as some have major impact both domestically and internationally, like; the Paris Agreement, EPA, Clean Power Plan, NAFTA, Trans-Pacific Partnership to name a few.
Perhaps the biggest near-term threat to ours and the global economy comes with how the new president chooses to go forward with threats to label China a currency manipulator. While few would argue that they have done so, China’s retaliation would likely be both economic, through tariffs, and military as they step up challenges on the sovereignty of islands and sea lanes near Taiwan and Japan. The fact that China has not manipulated their currency in the last two years and spent close to a trillion dollars to support it argues that cooler minds will prevail. But there’s little question that the Chinese face a tougher and less-predictable US leader in Donald Trump.
Clues as to how Mr. Trump and his advisers will navigate these and so many more challenging issues facing our country will come in the days and weeks ahead as he chooses people to fill critical positions of leadership. Ideally their character and experience will go a long way to diminishing the uncertainty that worries so many today. Hopefully Mr. Trump will find it in himself and his counselors to begin healing this country from his bully pulpit with inspiration and meaningful reforms for both political sides. Jobs and security are his mandate, but an economically healthy and secure nation is not worth living in without understanding, compassion, social justice, and healing. Mr. Trump, you are expert in gaining the trust of the half that voted for you. We pray you will find your way to reach the other half as well. By the way, we each have the same challenge; to understand as well as to be understood.