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U.S. Election

| November 09, 2016
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Market Reaction

Equities responded to Donald Trump’s epic, late-night upset victory by diving to “limit down” levels at 2:00 AM. But by this morning’s open they had stabilized; they are now showing life as market participants discard months of assumptions about the transfer of power and seek new signals.

Bond yields fell initially, but are now significantly higher with 10yr yields at 2.05 or about 18bps higher. In my opinion, this is due the reality that a good portion of his policies are net inflationary— inspiring bets that anticipated infrastructure spending and corporate tax cuts, which presage higher inflation. With that said, we recognize that a break-down in free trade could present unwelcome stagflation-baiting protectionism.

Legislative Agenda

Despite a GOP sweep of closely followed Senate seats so as to secure a majority, a turnkey agenda is not about to be made law immediately. More important now than the Republican/Democratic divide are frictions within the Republican party. The president-elect and the Congressional GOP, led by House Speaker Paul Ryan, have diverged on many policy priorities, and Congress still has the power of the purse. Indeed, while Ryan this morning referenced Trump’s “perfect tone,” he emphasized not Trump’s agenda, but his own—a far more detailed, six-plank platform he has been promoting for months.

In addition, this Congress is interested in restoring constitutional balance—a huge concern of House Republicans during Obama’s administration, and one of Ryan’s six planks. When Congress and the President agree on doing something major, they will do it; where they do not, they will not—or will discuss compromise, perhaps in private.

Many speculate that even this degree of certainty is ill-advised and that Ryan will lose his post, as his support of Trump’s candidacy was soft. I don’t consider such an outcome a slam dunk: Trump has every incentive to display the capacity to unify and work with a diversified GOP in Congress.

Against this tenuous balance, two major agenda items are shared across the GOP: economic growth, and repealing the Affordable Care Act (“Obamacare”).

• Growth Agenda

The growth agenda includes three core objectives: reducing the top corporate tax rate to 20%; repatriation of foreign earnings, with a tax rate of 10% on a going-forward basis, not as a “holiday”; and infrastructure spending of $300 billion over three years, funded by repatriation revenues.

Even these mandates, shared by Congress and the president-elect, could take nearly a year to accomplish. It is hard to act quickly in pursuit of policy and political bang for the buck.

• Affordable Care Act

Many in Congress are focusing on total repeal of President Obama’s signature legislative win. The question is what will follow. While alternatives received little attention during the presidential campaign, Ryan’s proposal includes three clear core elements: empowering states to administer exchanges without fed interference; engaging cost controls; and allowing greater consumer choice. It is an excellent starting point for a new political regime desperately in need of one.

• Other Policies

Trade: Far more divisive, even within Republican ranks, will be the coming discussion over trade. Trump has pledged to kill the Trans-Pacific Partnership (TPP); we shall see how his promise to exit or renegotiate bedrock agreements such as NAFTA ends. Prospects for significant global economic disruption cannot be dismissed.

Financial regulation: The lighter touch that Trump’s likely economic team will bring to financial services companies will no doubt aid companies in the sector. But outright repeal of Dodd-Frank is unlikely. The M&A environment will likely improve as well.

Energy: Trump has pledged to “unleash” domestic production, and key levers for doing so are at the president’s fingertips. This promises greater flexibility and profit for several segments of the energy patch, and lower costs for consumers, helping keep a lid on inflationary pressure.

Federal Reserve

We consider the Fed, ever “data-dependent,” to be still poised to go in December unless markets really crater. The question is what pace to anticipate after that.

Fiscal stimulus is coming in 2017, and a big package would push the Fed toward greater tightening. This is consistent with two hikes in 2017, particularly when considered in concert with Trump’s inflationary infrastructure and tax-reform objectives.

Trump’s core views about the Fed may also come to affect both monetary policy and market nerves. He has been hostile to Fed independence, and while the body is accountable to Congress rather than to the President, Fed Chair Janet Yellen’s resignation or dismissal cannot be ruled out.

What is sure is that Trump will nominate two new Governors to fill current board vacancies, and nominate Yellen’s successor for Senate confirmation in Feb. 2018. We will keep close eye on Governors to glean insights on the personalities and their philosophy of monetary action. Possible names include Harvard professor, and GOP luminary, Martin Feldstein and Richard Fischer.

One other thought: Trump is a real estate executive who understands the benefits of low rates in his own professional experience. His view has repeatedly proved somewhat simplistic—as his repeated debt-related bankruptcies have proved—but could prove a basis for interpreting his statements on what he wants to see at the Fed in the future. The broader point here is that the antagonistic tone candidate Trump expressed toward Ms. Yellen and the Fed over the last several months could turn more dovish and pragmatic after the inauguration.

While much in America has been shaken up in the past few hours, the coming-to-terms that markets have shown even as I penned this letter suggests much remains the same, regardless of who won last night. We welcome your thoughts and questions.


Aaron J. Kennon


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