The basic assumption by markets at the moment is that President Trump and the Republican administration will engage in fiscal stimulus. The question to ask is whether that fiscal stimulus is successful or whether it will end in failure. If it is successful then perhaps it will lead to US dollar strength and growth both in the US and the rest of the world and perhaps even a normalisation of the US Treasury curve. If it doesn’t succeed, as many people expect, then likely there will be a reversal of market expectations, an increase in policy uncertainty and perhaps a lower growth profile than currently priced in. These two routes have very different outcomes for the prospects of emerging market fixed income and equity markets.
There are some variables around this. First, think about President Trump and his tweets: they generate a significant amount of headline risk as we have seen already in the early weeks of his administration. That in turn creates uncertainty and perhaps a higher risk premium for some of the emerging markets such as China and Mexico and even for developed markets like Europe. It is too early to tell the result of this rhetoric but there is definitely a whiff of protectionism in the air.
The other variable is whether the Republicans in control of Congress have a high enough tolerance to increase the deficit in order to engage in this type of fiscal stimulus, which is not particularly clear to us at this point. Putting all this together, we believe the level of uncertainty in markets is going to fluctuate a lot over the next few months.
Colm McDonagh – Insight, a BNY Mellon company