US: What 2017 has in store for the world’s biggest economy - BBH

Marc Chandler, Research Analyst at BBH, suggests that a new and unorthodox administration in US will formally take office in late January, but Trump’s impact is already being felt.

Key Quotes

“The equity and bond market response to the election results is largely in line with the market’s response to Reagan’s election in 1980. The dollar has outperformed.”

“Our dollar bullish view was based on the significance we attributed to financial and monetary divergence. On top of that, we place the more precarious European political situation. Then, as the US primaries unfolded, it became increasingly clear to us that whoever won, fiscal policy would become easier.”

“There are many unknowns, but the market seems to be anticipating lower corporate taxes, easier regulation, and better profits. It is also anticipating somewhat higher inflation and an accelerated timeline for gradual normalization of US monetary policy. During the campaign, President-elect Trump was critical of Yellen and the Federal Reserve. Investors may be pleasantly surprised to find that in office, Trump will likely respect the independence of the Federal Reserve.”

“Trump will likely be able to mould the Federal Reserve into the central bank he wants. There are currently two vacancies on the seven member Board of Governors. Of those, it is assumed one will become the Chair when Yellen’s term expires in February 2018. Vice-Chairman Fischer’s term ends in June 2018.”

“In 2017, we expect Yellen to continue to normalize the Federal Reserve’s monetary policy. The December FOMC meeting resulted in a rate hike, and economic projections anticipate that three rate hikes would be appropriate in 2017. This is not a commitment, of course, and it does not include any potential changes to fiscal policy.”

"We would place the risk on the upside. The Fed’s objectives of full employment and 2.0% core PCE deflator are within view. Somewhat quicker tightening may be forthcoming if wage growth is evident and sustained. We do expect some fiscal stimulus even if it is not the $1 trillion that has been widely discussed. That said, rapid dollar appreciation, on a real trade-weighted basis, might give the Fed pause, especially if stronger world demand does not materialize.”

“The Federal Reserve is unlikely to pre-emptively turn more aggressive even when the new president provides more details of his fiscal intentions. It is only prudent and practical to see what is eventually negotiated, and when it is implemented. If the economy is going through a soft patch, for example, as it appears to have exited near midyear, the fiscal stimulus could be delivered at an opportune time. On the other hand, if the unemployment rate is threatening to fall below 4%, the economy is growing above trend, and prices are accelerating, a different response may be necessary.”