The market's response to Trump's 2016 victory provides a crucial backdrop for evaluating potential outcomes if he were to secure a second win in the upcoming election. Notably, in 2016, the US bond market underwent a significant shift as the central bank had just initiated a cycle of interest rate hikes, contributing to a substantial sell-off. This sell-off, coupled with expectations that Trump's proposed tax cuts would stimulate the economy, led to the highest increase in 10-year Treasury yields in over seven years. Bond funds experienced significant outflows, reminiscent of the "taper tantrum" in 2013. As we read in Bloomberg.
The current scenario is distinct, with the key question being the extent to which Trump's policy proposals, either as the party's nominee or the re-elected president, might influence the current market expectations for interest rate cuts. Analysts, such as Gennadiy Goldberg of TD Securities, emphasize the importance of evaluating tax and growth implications, deficit impact, and regulatory changes, as these factors play a crucial role in shaping market dynamics.
However, the fiscal impact of the upcoming election may be less pronounced than in 2016. The focus is likely to revolve around whether to extend Trump's 2017 tax cuts rather than introducing new ones. Additionally, Joe Biden's oversight of an expansionary fiscal policy has already left the government dealing with substantial deficits, especially given the near-full employment situation. The looming question is which candidate is more likely to generate a higher deficit, a concern that is currently applicable to both candidates.
The control of Congress by the winning party is another pivotal factor. A divided government could result in gridlock, affecting the implementation of proposed policies. Analysts from Goldman Sachs suggest that a scenario where Republicans control both the White House and Congress may lead to higher bond yields, particularly on longer-dated securities, as it keeps the Federal Reserve vigilant against potential economic overheating.
In terms of currency dynamics, higher bond yields could positively impact the US dollar. The currency, which initially surged after Trump's 2016 victory, experienced a subsequent decline in 2017 as the US economy slowed while European growth picked up. The imposition of tariffs, if successful, could potentially boost the US dollar by curbing imports and limiting the outflow of dollars.
Deutsche Bank strategist Alan Ruskin notes that the "Trump effect" is inherently positive for the dollar, especially against currencies like the euro, yuan, and Mexican peso. The Mexican peso and Chinese yuan are expected to face additional pressure if a Trump victory seems likely as the election approaches. Deutsche Bank strategists anticipate the US dollar remaining within 2023's ranges throughout the election year, building a safe-haven premium as election risks escalate.
Turning to the US stock market, its trajectory is closely tied to the Federal Reserve's ability to manage interest rates effectively and guide the economy toward a soft landing. The global stock markets were arguably more unstable in early 2016, facing rising rates and a global oil glut. The S&P 500, however, rose steadily for most of that year and experienced a surge in the two months following Trump's victory.
Trump's policies had varying impacts on different sectors. Defense contractors like Lockheed Martin and Northrop Grumman thrived under his America First rhetoric, while Caterpillar, despite the unfulfilled promise of a major infrastructure plan, saw substantial gains. However, the overall performance of the so-called "Trump trades" lagged behind the S&P 500 during his term, leaving investors cautious about predicting winners and losers, especially given macroeconomic forces that often overshadow election-related speculations.
In conclusion, the market's response to Trump's 2016 victory serves as a valuable reference point for assessing potential outcomes in the event of a second win in the upcoming election. The interconnectedness of fiscal policies, interest rates, currency dynamics, and stock market performance underscores the complexity of predicting market reactions, particularly in the current economic cycle. Investors are navigating uncertainties and weighing the potential impacts of political developments against broader macroeconomic trends.
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