U.S. voters elected Donald Trump as the next president, while the House and Senate retained narrow Republican majorities. Scott Mather, CIO for U.S.
core strategies, and Libby Cantrill, head of public policy, discuss PIMCO’s outlook for policy, the economy and global markets in light of the
election, along with implications for investors.
Q: What are the likely near-term policy priorities under the Trump administration and Republican Congress?
Trade is one issue where Trump has been vocal for years. We will likely be in a more protectionist, anti-trade environment, especially considering the
executive branch holds significant authority over trade decisions and treaties. The Trans-Pacific Partnership won’t proceed, for example, and Trump has
indicated he would renegotiate or potentially even withdraw the U.S. from NAFTA (the North American Free Trade Agreement implemented in 1994).
His messages throughout the campaign also suggest Trump will focus on a protectionist immigration policy, hewing to a wider global populist trend, but
details aren’t clear.
Outside of trade and immigration, other policies the Trump administration is likely to pursue should be more supportive of U.S. growth. Corporate tax
reform, individual tax reform and infrastructure spending (where Trump has proposed programs up to $1 trillion over five years) are now more likely given
the Republican majorities in both the House and the Senate.
We will likely see efforts toward financial deregulation, such as modifications to Dodd-Frank or the DOL fiduciary rule, though wholesale rollbacks are
unlikely. A more limited expansion in the regulatory burden could help boost business confidence and investment spending. We are also likely to see Trump
and the Congressional Republicans aim to repeal Obamacare.
We do expect Trump to tend to defer to Congressional Republicans in many of the areas where they’ve already laid the foundation for change, such as tax
reform and the repeal of Obamacare; markets are likely to respond favorably.
Q: How do we expect markets will respond to Trump’s victory over the coming days, weeks and months, and what are the implications for investors?
Three areas of the market we’re watching closely are volatility, inflation and currencies.
Volatility will likely increase substantially from the generally low levels we saw over much of this year. Central bank policy probably won’t limit
volatility to the extent it has over the past several years, and we see potential for widening risk premia and credit spreads.
Both near term and also over the longer term, investors may want to position for higher inflation. Over the past several years, the markets have fluctuated
between romancing different degrees of disinflation and failure to reach the inflation target. Going forward we think markets are likely to price a much
more balanced view, weighing the possibility of an inflation overshoot at least as heavily as an inflation undershoot thanks to likely growth-friendly
policies and a cautious central bank. At PIMCO, we have been preparing our portfolios for some time, emphasizing a defensive posture that hedges portfolios
from those rising inflation expectations.
Finally, we expect increased pressure on the U.S. dollar to appreciate, strengthening in particular versus emerging market currencies. It’s a more mixed
picture versus other developed market currencies as international investors seek alternatives to the dollar as a reserve currency. Our currency view has us
looking across the currency spectrum for long-term pockets of value, especially in emerging market currencies, for instance the Mexican peso – which is
feeling the impact of the Trump victory in light of his stance on trade – as well as the Brazilian real.
Q: How should investors be thinking about risk?
In general, we have been encouraging investors to consider a more defensive posture. That’s what we’ve been doing in most of our strategies, in different
ways depending on the strategy. We still think the defensive approach is appropriate because of the likelihood of rising uncertainty and volatility, which
will create risks but opportunities as well. Active investment management offers the flexibility to target those opportunities.
Bigger picture, we believe it’s important – especially in tumultuous times like this – for investors not to focus entirely on the downside, but to take a
much more balanced view. As always there’s a distribution of risks for financial markets, and especially over the secular horizon we see widening tails on
both sides of that distribution: negative and positive. Scenario analysis is critical to portfolio management; especially in light of all the near-term
uncertainties that could rattle markets, we believe it’s important to gather and assess information before taking a long-term investment stance. Specific
to the post-election environment, we see a number of potential positives over the medium term as well as some potential negatives – it will be important to
analyze the policy as it’s unveiled and make investment decisions accordingly.
Q: Has the election changed PIMCO’s outlook for monetary policy?
Going into the election, the markets were pricing a very high likelihood of the Federal Reserve hiking the policy rate at the December meeting. We still
think that’s likely, though near-term uncertainty may slightly reduce the probability, and the decision would depend upon financial conditions. We think
that even if conditions are a little bit tighter, and we see more market uncertainty, it will likely be offset by the higher inflation expectations I
mentioned earlier. So on balance, we think it’s likely that the Fed will acknowledge a market that’s already pricing in a pretty significant probability of
a December rate hike, and then go ahead with the move.
Looking at the more cyclical trajectory for the Fed, prior to the election, we thought the Fed might move two or three times before the end of 2017 (as we
discussed in our latest Cyclical Outlook
). While that’s a little faster than what the market is pricing, it is still our base case. It’s too early to say what influence Trump may have on Fed
leadership and its reaction function, as new appointments are required to fill existing vacancies and Chair Janet Yellen’s term expires in 2018.
Q: What should investors be watching for from the Trump administration in the near term?
In the days and the weeks ahead, investors and markets will spend much energy forecasting and later scrutinizing the individuals Donald Trump puts in place
as advisors, both his economic advisors and chief of staff in the White House as well as important cabinet positions in the Treasury and State Departments.
Investors will also be looking for more details on Trump’s economic agenda; at this point he’s only provided broad brush strokes. Investors would likely be
comforted if he provides some more details prior to his inauguration in January.