Global daily insight 11 november 2016

Daily Insight

Group Economics Macro & Financial Markets Research

11 November 2016

Quantifying Trump’s economic plans (…and the bond sell-off) US Presidential Elections: Trump by the numbers – There is a lot of uncertainty about Macro & Financial Markets Research Team

President-elect Trump’s economic plans. They have a number of main strands: (1) fiscal

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stimulus via tax cuts and infrastructure spending (2) reduction of immigration (3) reigning

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back free trade agreements – especially NAFTA (4) interfering with the independence of the

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Fed. What Mr Trump will focus on (first) and what he will agree with Congress is unclear.

However, it seems to us that that fiscal stimulus and immigration will probably be a priority compared to protectionism, while early signs are that he will leave Chair Yellen in place. So how big might the fiscal stimulus be? What impact might reducing immigration have on labour force growth? Below we try to attach some numbers to these plans, even though the ultimate policies are at this stage uncertain. While the fiscal stimulus would boost demand, curbing immigration would reduce supply. This combination points to higher inflation and possibly more Fed rate hikes, which is the reason for the global bond market sell-off we have seen since the election results (see below). (Nick Kounis & Maritza Cabezas) Size of the Trump fiscal stimulus - There are two elements to the fiscal stimulus. The first is an increase in infrastructure spending. Mr Trump has not given many details here apart from saying that his plan would be ‘double’ the size Ms Clinton’s package. That points to spending of USD 550bn over a 5-year period, worth around 0.5% GDP per annum. Mr Trump’s initial package of tax cuts – which would significantly reduce marginal tax rates for both households and businesses - have been estimated by the Tax Policy Center as being worth an enormous 4% GDP in 2017-2018. However, there are signs that the Presidentelect is converging towards the more modest tax plans of House Speaker Paul Ryan. The House Republican tax reform blueprint is estimated by the same institution to be worth 2% GDP over 2017-2018. Assuming that Mr Trump would go with the more modest tax plan, and taken together with the infrastructure spending, the total fiscal stimulus in 2017-2018 would be 3% GDP. This would significantly increase US economic growth over the period all other things being equal.

Trump’s policies on immigration and impact on the labour market – Mr Trump has proposed reducing both legal and illegal immigration. His immigration plan proposes to ensure that job openings are offered to American workers first. Other proposals relate to reducing illegal immigration, both through enforcing current law and by implementing new policies. On top of this, Mr Trump on many occasions has said he would deport roughly 11 million unauthorized immigrants from the US. Finally, he plans to deliver a wall on the

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Bloomberg: ABNM

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Daily Insight - Quantifying Trump’s economic plans (…and the bond sell-off) – 22 July 2016

southern border. Given the tight labour market, the impact of these measures could be large depending on the scope of the policies. At current levels of around one million immigrants per year, immigration is an important source of labour supply and economic activity.

Moreover, an increase in labour supply due to immigration lowers wages. Migrants represent around 0.6% of the total labour force per annum. If we assume that around a third of the immigrant flow declines in one year, then the labour force would slow by around 0.2%-points and unemployment would – other things being equal - decline by a similar amount. Higher economic growth due to the fiscal stimulus would also push down unemployment, leading to a tighter labour market and higher wages. Although these are back of the envelop calculations, they give an indication of the effect that these type of measures. A more radial stance of deporting “all” illegal immigrants could have much larger economic implications.

Global government bonds: The sell-off continues – Wednesday’s sell off in government bond markets continued on Thursday. After having risen through 2% after the election, US 10y Treasury yields rose further, by another 3bp to reach 2.07% at time of writing. Europe’s government bond markets started to catch up, with German 10y bond yields up by 8bp to 0.28%. Curves steepened with long end yields rising more significantly. Financial markets have started to price in more Fed rate hikes next year, as well as higher long-term inflation.

Although this seems reasonable for the US (see above), the narrative is much less convincing for the eurozone. Eurozone headline inflation is set to rise over the coming months, but core inflation is likely to remain very weak and indeed could fall further. Higher US inflation and more Fed rate hikes would mainly impact eurozone inflation through a stronger dollar and hence weaker euro. Admittedly EUR/USD has fallen, but this is not big enough to significantly change the inflation outlook and we still expect an extension of QE. So the sell-off in the German bonds seems to be more a contagion from the US rather than being fundamentally driven. Meanwhile, peripheral yields rose even more sharply, especially in Italy. This seems to reflect the view that the US elections increase political risk in the eurozone as well, as populist forces might be underestimated by the opinion polls. We indeed see Italy as representing the biggest political risk in the eurozone in the near term, given the upcoming referendum. (Nick Kounis)

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Daily Insight - Quantifying Trump’s economic plans (…and the bond sell-off) – 22 July 2016

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Daily Insight - Quantifying Trump’s economic plans (…and the bond sell-off) – 22 July 2016