News in Charts: Who Won the US election: ‘Trump Lite’ or ‘Donald Dark’?

In our latest quarterly forecast, finalized over a month ago, we took the ‘out-of-consensus’ view that, on balance of probabilities, a victory for Donald Trump would lead to faster US economic growth than the alternative. But the speed at which equity investors seem to have priced in this outcome, which we dubbed ‘Trump Lite’, has been remarkable. Have investors got ahead of themselves? The answer hinges on how US fiscal and trade policies evolve under the new administration. The bottom line is that, while our central view is now a period of quite robust US growth, a lurch towards greater trade protectionism in the US and elsewhere remains a significant risk.

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Last week, Donald Trump took many observers by surprise with what was, on the face of it, a gracious and conciliatory acceptance speech. And by and large he has kept up this more presidential tone since then, describing his meeting with Barack Obama as “terrific” and “unbelievably interesting” and referring to the Clinton’s as “good people”. This tone stands in sharp contrast to the divisive rhetoric of his entire election campaign. This U-turn has raised hopes that Donald Trump will be a pragmatic and responsible president, and investors have recalibrated their expectations accordingly.

In our Global Economic and Markets Outlook for 2016 Q4, put together several weeks before the election, we argued that a Donald Trump presidency was likely to produce slightly faster US economic growth than the alternative, which would have entailed much more of a ‘business-as-usual’ approach. In other words, and contrary to popular belief, a Republican victory need not have been quite the disaster that many imagined. This conclusion rested on an assumption that, after taking office, Mr Trump would quietly shelve some of his more controversial proposals, particularly on trade and immigration. At the same time, he would pursue his more expansionary plans to cut taxes and increase spending on the military.

Since making that forecast, Mr Trump has rowed back from his pre-election position even more rapidly than we expected. It also transpires that he plans even more fiscal stimulus than we had previously imagined, in the form of infrastructure spending. In the event, the risk-off sentiment that followed Donald Trump’s win, which we had expected to last for a number of weeks, lasted less than a day.

The upshot of these developments is that we are revising up our US GDP forecasts under the ‘Trump Lite’ scenario, to 2.9% in 2017 and 3.1% in 2018. These estimates might be considered conservative, as they assume a somewhat smaller-than-usual fiscal multiplier. But in our view this is reasonable, given the relatively small economic return to tax cuts for the rich.

How much?!

Mr Trump’s tax plan is estimated to reduce federal revenues by between US$4.4 trillion and US$6.2 trillion over ten years, before accounting for interest costs and macroeconomic effects. This implies tax cuts of between US$440 billion and US$620 billion per year, equivalent to roughly 3% of US GDP. Proponents of the plan, which is very similar to the plan put forward by Republican House Speaker Paul Ryan earlier this year (meaning it should receive backing in Congress), claim that these cuts will not only boost economic output, they will pay for themselves. We disagree. Such an aggressive fiscal expansion will undoubtedly raise economic growth, but at the expense of a ballooning fiscal deficit. To the extent that the Laffer curve exists, the US is almost certainly on the upward- rather than the downward-sloping portion.

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Mr Trump also plans to increase infrastructure spending by US$550 billion. Obtaining approval for this plan in Congress will be more difficult, but not impossible. Paul Ryan has spoken enthusiastically about the mandate that voters have given Mr Trump. And these plans are at the top of Mr Trump’s agenda. Even if fiscally-conservative Republicans were to block him, he could receive Congressional support from Democrats such as Bernie Sanders, who, in an interview with CNN, said: “I hope [Mr Trump] will rebuild our crumbling infrastructure. And I look forward to working with him if he chooses to do that and create millions of decent paying jobs”. Mr Trump is also likely to increase US military spending, which is currently around US$730 billion per year, nearly 4% of GDP.

Trade war. What trade war?

Since taking office Mr Trump has dramatically toned down his inflammatory rhetoric on trade and there has been no mention of tariffs on imports, either from China or Mexico. In reality, Mr Trump was never likely to deliver much of what he pledged during his campaign. However, it is also unreasonable to assume that Mr Trump will do nothing on trade.

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A paper published by Mr Trump’s economic team before the election offers key insights into his position on this subject. The report is particularly critical of China and its trade practices, which, it claims, include illegal export subsidies, theft of intellectual property, currency manipulation, forced technology transfer and a reliance upon “sweat shop” labor and pollution havens. The report complains about the WTO’s inefficient dispute resolution mechanisms and suggested that a Trump administration might be prepared to walk away from the WTO.

Instead of tearing up existing trade agreements, the most likely outcome is that Mr Trump will seek to renegotiate them in a way that encourages the onshoring of manufacturing jobs to the US. With a large share of their exports destined to the US, it is in other countries’ interests to seek common ground and accommodate some of Mr Trump’s concerns.

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Nevertheless, the various contradictions in Mr Trump’s stance are likely to cause tension. He intends to brand China a currency manipulator, yet if China were to let its currency float freely, it would probably depreciate against the US dollar. Mr Trump is critical of China’s environmental policies yet has promised to walk away from the Paris Climate deal himself. In short, ironing out these differences may be difficult, and in some cases irreconcilable, meaning the possibility of a full-blown trade war between the world’s two largest economies cannot be ignored.

Writing in the Times earlier this week, Patrick Hosking implicitly described the market reaction to Mr Trump’s victory as somewhat naive: “Mr Trump has flip-flopped on which party he supports five times in the past two decades. He has been pro-life and pro-choice. But on free trade he’s been uncharacteristically consistent. He doesn’t like it.” Mr Hosking drew attention to a recent report from the Petersen Institute, which conclude that: “He has repeated these [anti-trade] views since at least the 1980’s, suggesting that he may actually hold them.”

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Another threat to global trade and global growth is the boost that Mr Trump’s victory is likely to provide to isolationist movements elsewhere in the world. And although Mr Trump’s behavior has encouraged investors after his win, concerns around his temperament have not disappeared.

The upshot is that while it may have been a better-than-expected start by Mr Trump, it is premature to conclude that we are clearly in a ‘Trump Lite’ world. In putting together our latest quarterly forecast, we gave our risk scenario ‘Donald Dark’ a weight of just 15%. Our central scenario – a Hillary Clinton win – had a weight of 50%. Implicitly, with Donald Trump soon to move into the White House, the downside scenario now has around a 1-in-3 chance. We are not minded to alter that probability just yet.