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<b>Abheek Barua & Bidisha Ganguly:</b> The Trump trade

Markets may have reacted too sharply and taken every word of Trump's campaign rhetoric at face value

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Abheek BaruaBidisha Ganguly
Well here’s what Mr. Trump’s somewhat unanticipated election win has done to financial and commodity markets. Since the election results came out, the three biggest losers among asset categories are the Mexican peso, US bonds and emerging market stocks. The biggest gainers have been iron ore and copper followed by US stocks. This in a nutshell reflects the so-called Trump trade — buy commodities and American stocks, dump US bonds and any financial assets that would be hurt by protectionist policies and rising US interest rates.

Thus the sharp fall in the Mexican peso (about 13 per cent since the election results came in) should be easy to explain since it faces the risk of a sharp rise in tariffs on its exports to the US, the possible curb on immigration and the prospect of NAFTA being dismantled. The other price movements perhaps deserve some more explanation. Commodities are riding high on the expectation that Trump will implement his promise of massive spending on infrastructure that would create an immediate demand for these things. US stocks are climbing up on the hope that increased government spending will pump-prime the economy leading to a rise in overall growth and company earnings. The consensus among investors is that Trump will create stimulus of a percentage of the GDP to government from 2017 to 2021.
 

However, the rally in stocks has left some sectors behind — renewable energy shares have taken a hit in response to Mr. Trump’s promise to revive the coal industry and his general disdain for the climate change agenda. Health care stocks are on edge in anticipation of what a repeal of Obamacare would mean for them. Construction and defence (another sector where expenditure could go up) on the other hand are clear winners.

However, his promise to spend more on infrastructure while slashing income taxes across the board clearly doesn’t bode well for the budget deficit. Thus, the Trump government could end up borrowing a lot and add substantially to sovereign debt that is already at a far-from-comfortable 105 per cent of the GDP. The US government 10-year bond yield has gone up by about half a percentage that is really huge by bond market standards. Driving the sharp drop in the bond market is unprecedented selling of US Treasuries by foreign central banks led by China.

The surge in bond yields that will ultimately reflect in borrowing costs in the economy is driven by a couple of other factors. The president-elect has been extremely critical of the US central bank’s (the Fed) ultra-loose monetary policy and there is a fear that he will sack the current Fed boss Janet Yellen and replace her with someone who has a far harder line on inflation. Besides, Republicans favour a rule-based monetary policy (to put things in perspective, quantitative easing was the most extreme form of discretion) and conventional monetary rules would favour a much higher interest rate than the current level. Finally, inflation expectations are rising as the fear of stagflation — weak growth with higher prices driven by high tariffs, reduced outsourcing and the like — builds up.

For emerging markets (EMs), these are hard times. A US government that explicitly favours protectionism is negative for virtually all EMs since all of them depend on trade with the US for growth. For a large service exporter like India, the prospect of a curb on H-1B visas certainly doesn’t augur well. Thus, the received wisdom that if the US grows it is bound to be good for the emerging world is likely to fail. However, the main threat is that of rapidly rising US interest rates. This could reverse the “carry-trade” funded by borrowing dollars at low interest rates to buy high yielding emerging assets. Besides, a number of these markets that are sitting on piles of debt that would get harder to service as their currencies falter against the dollar.

There is a possibility that markets have reacted too sharply and taken every word of Trump’s campaign rhetoric at face value. As he sits at his desk at the Oval Office, President Trump could take a much a softer line on some of his pet peeves like immigration and protection. We can, at least, hope that he does.

Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper

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First Published: Nov 20 2016 | 9:40 PM IST

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