US Special

US Special

The Trump Timeline

9 November 2016

Financial Markets Research

Marketing Communication

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JPahniliLpaMmabrtesy

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Senior US Strategist

+3130? 216 9721

philip.marey@

Summary

Trump wants to provide the US economy with a much needed fiscal policy stimulus. The fiscal impulse will be larger and reach the economy earlier if the Republican Party indeed controls both the White House and the Congress.

A Trump presidency will benefit high income groups and businesses the most. The effects of his fiscal policy plans on economic sectors will be asymmetric. A Trump presidency will

benefit the fossil energy sector, the defense industry and infrastructure. Unfortunately, the impact of the fiscal impulse will be weakened by protectionism. In case of a trade

war (which could break out in early 2017), the first negative domestic impact will be on US importing firms, followed by US exporting firms if trading partners retaliate. Even services firms in trade intensive regions may be affected negatively. The more effective the fiscal impulse, the faster the Fed can hike in 2017 and beyond. Both effects should have an upward impact on rates. However, episodes of risk aversion due to trade conflicts could push rates down again temporarily. In case of a full scale trade war this downward effect will be more sustained, especially if the economy falls into recession. What's more, the positive impact of the fiscal impulse could be offset by possible trade conflicts. This could still prevent the Fed from hiking in 2017. President Trump is expected to replace current Fed Chair Yellen when her term expires in February 2018, which could lead to the Fed changing its course. By the time Trump runs for re-election, four years may have passed without a serious effort to curb the unsustainable spending on entitlement programs and the rising public debt.

Introduction

Now that Trump is likely to become the next President of the United States, and the Republicans are likely to maintain their majorities in the Senate and the House of Representatives, we are able to provide the most likely timeline for the key events for the economy and markets after Election Day. In order to build the timeline, we have taken a close look at the fiscal policy proposals of Trump, his trade policies, and other policy plans that will affect the economy and markets.

While the US President can take trade policy measures without much interference from Congress, fiscal policy bills are written by Congress and can only be signed or vetoed by the President. This means that the new President can set trade policy starting on January 20, 2017, while new fiscal policy will take more time and negotiations with the House of Representatives and the Senate. In fact, the size, shape, and timing of the fiscal policy impulse will not only depend on who wins the White House, but also on which party gets a majority in the Senate and the House of Representatives. In turn, the impact of the fiscal policy impulse on the economy ? and possible trade conflicts ? will affect the Fed's monetary policy.

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9 November 2016

The Trump Timeline

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The US fiscal policy matrix revisited: Republican Control

While the US President has the lead in trade policy, he is dependent on Congress to implement his or her fiscal policy ideas. Earlier this year, in The US fiscal policy risk matrix, we summarized the fiscal policy risks that could arise under different election outcomes. We argued that the nature of the fiscal policy regime does not only depend on who gains control of the White House, but also on which party has the majority in the Senate and the House of Representatives.

We categorized the possible election results into three outcomes: Divided Government, Republican Control, and Democratic Control. In case of Republican Control, Trump is the new President, and both the Senate and the House of Representatives remain in control of the Republicans. In case of Democratic Control, Clinton is the new President, and the Democrats gain majorities in both the Senate and the House of Representatives. In case of Divided Government, no single party is in control of the White House, the Senate and the House of Representatives at the same time.

While the US fiscal policy risk matrix was designed as a generic framework to analyze the interaction of Democrats and Republicans, we can be more specific now that the presidential candidates have provided more specifics regarding their fiscal policy plans. We can simplify the matrix because we now know that we have a situation of Republican Control.

Figure 1: The US fiscal policy risk matrix revisited

Source: Rabobank Financial Markets Research

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9 November 2016

The Trump Timeline

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The fiscal policy impulse

If the Republicans take control of the White House, and remain in control of the Senate and the House of Representatives, fiscal policy is likely to focus on tax cuts, although House Speaker Paul Ryan ? who is known as a budget hawk ? may try to squeeze in some spending cuts to mitigate the expansionary impact on the budget deficit. Trump's tax proposals would reduce taxes for all income groups, but the higher incomes would benefit the most. This is ironic since his rise to the Republican nomination has been attributed to a revolt by blue collar voters. On balance, Trump's tax proposals would lower tax revenue. The bulk of the loss would come from reduced business taxes. This would give the economy a fiscal impulse which would be amplified by his proposals for government spending on infrastructure and defense. However, because of the large tax cuts his proposals would probably have an even larger upward impact on the budget deficit and the public debt than Clinton's plans. Under Republican control a fiscal impulse could also be implemented rapidly, depending on Trump's relationship with the Republican leadership in the House and the Senate.

Trump does not seem to focus on getting entitlement spending under control, which will continue to push up the public debt. This will hurt the long-term outlook for the US economy. Meanwhile in the short run, while a fiscal policy impulse would boost economic growth, other policies could lessen its effect, in particular protectionist measures and increased government regulation.

Dampening the fiscal policy impulse: protectionism and regulation

The positive impact of the fiscal impulse will weakened by the protectionist measures of a new President. Protectionist tendencies could undermine world growth and backfire on the US economy. In our recent special The Trump Trade War Game we had an in depth look at the legal powers of the US President to take protectionist measures without approval from Congress. It showed that a President Trump could start taking protectionist measures on his first day in office, which is January 20, 2017. We took a game-theoretic approach to analyze the possible outcomes of a trade conflict and we found historical precedents of these outcomes. This game of brinkmanship has three possible outcomes: victory for the US, a tie, or a trade war. Ironically, victory for the US is positively dependent on a President Trump's perceived "irrationality" and the rationality of the trading partner. If both act rationally it will be a tie. If both behave irrationally, we will have a trade war.

Table 1: Fiscal policy impulse

Aspect of fiscal impulse Main channel of fiscal impulse Dampening of fiscal impulse Size of fiscal impulse Timing of fiscal impulse

Effect on budget deficit and public debt Effect on income distribution

Source: Rabobank Financial Markets Research

Donald Trump Lower taxes Trade war Substantial (in case of Republican Control) Reaches the economy in 2017 (in case of Republican Control) Increase Less equal

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9 November 2016

The Trump Timeline

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Asymmetric sectoral effects

So far we have focused on the impact of a fiscal impulse on the economy as a whole, slowed down by protectionism. However, the policy plans of Trump would also have asymmetric effects on different sectors of the economy. From a macroeconomic perspective this will affect the contribution of various sectors to GDP growth through business investment and net exports. What's more, it will also affect where jobs will be created in the coming years.

For example, the energy and environmental policies of Trump clearly reflect his preferences on renewal energy and fossil energy.

Trump wants to withdraw from the Paris Agreement under the UN Framework Convention on Climate Change that was signed in 2015 and becomes effective on November 4 this year. He wants to roll back both President Obama's Clean Power Plan (CPP) and the production tax credit for renewables. Instead, he would approve the Keystone XL pipeline and support fracking. Note that the Supreme Court nomination by the new President will also affect the outcome of appeals regarding the CPP. More generally, he wants to deregulate natural gas, oil and coal production and lift restrictions on drilling on federal lands.

A Trump presidency could benefit the defense industry, however if he starts a trade war that could lead to retaliation by trading partners and hurt US exports of defense products.

Finally, both parties do agree on the need to improve the nation's infrastructure. In fact, increased government spending on infrastructure is a key component in the fiscal stimulus package of both candidates.

However, in the event of a trade war, there will be an across the board negative impact on domestic sectors in three phases. In the first phase, which may start on January 20, 2017, a raise of US tariffs on imports from countries like China and Mexico would hurt US importers. In the second phase, which could follow shortly, a decision by targeted trading partners to retaliate would affect US exporters. Finally, in regions with a high intensity of exporting and/or importing firms, the US services sector would in the end be affected as well as they face decreased demand from struggling clients.

Impact on monetary policy

A fiscal impulse would also have implications for the Fed. In fact, several Fed speakers have stressed the importance of fiscal policy in boosting economic growth, as monetary policy has its limitations. The growth boost from a fiscal impulse would reduce the burden on the Fed and allow the central bank to remove its monetary policy accommodation more rapidly. In other words, the FOMC could increase the pace of the hiking cycle. Higher growth and higher policy rates would also raise longer-term interest rates. Once the Fed speeds up the hiking cycle, there would be an additional boost to treasury yields, with some flattening of the curve. However, the positive impact of the fiscal impulse could be offset by possible trade conflicts. This could still prevent the Fed from hiking in 2017.

Beyond 2017, the Fed's independence will be at stake, especially if the Republicans keep their majority in the Senate. Current Fed Chair Yellen's term expires in February 2018 and Trump has already threatened to replace her. This could change the Fed's course after February 2018. We do not expect Yellen to step down voluntarily and prematurely. After all, this would set a dangerous precedent for the Fed.

Timeline of market impact

In response to the Trump victory, we may see an initial bout of risk aversion as markets consider political uncertainty to be higher for this outcome. However, he will not take office until January 20, 2017, so markets are likely to stabilize well before the end of the year. Nevertheless, the possibility of a trade war in 2017 will reduce expectations about US GDP growth and the Fed's hiking path. This should continue to depress US treasury yields. In fact, Trump's trade policies are likely to have a bigger market impact

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The Trump Timeline

9 November 2016

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than his fiscal policies. If he decides to launch protectionist measures against China and Mexico, Inauguration Day could be the start of risk-off episodes in markets caused by trade conflicts that we described in detail in The Trump Trade War Game. The markets will shift to a risk-on mode if the trade war game ends in a Reagan- or Bush-scenario. However, there is a high risk of recession if the game ends in a trade war, depressing stock prices and treasury yields for a sustained period. In this case, the fiscal stimulus could soften the recession somewhat. If a full scale trade war is averted, the fiscal impulse could boost the economic recovery that has been disappointing so far.

We now wrap up our discussion of the consequences of a Trump presidency for the economy and markets in a timeline with Republican Control (Table 2). While this timeline is obviously highly speculative, we provide it to sketch the events that we are likely to face after Election Day. In the coming days and months we will get a clearer picture of what the prevailing timeline will exactly look like.

Table 2: The Trump Timeline in case of Republican Control

Date 9 November 2016: Day after Election Day 14 December 2016: FOMC Decision 20 January 2017: Inauguration Day (and beyond) A few months after 20 January 2017

15 March 2017 During the course of 2017

1 October 2017: Start of Fiscal Year 2018 June- Dec 2017 February 2018

Donald Trump Brief risk-off episode due to policy uncertainty Fed hike, provided that markets have stabilized Start of risk-off episodes caused by trade conflict, risk-on if game ends in Reagan- or Bush-scenario Substantial fiscal stimulus package passes through Congress Debt limit raised without difficulty Substantial fiscal impulse to reach the economy, boosting stock prices and treasury yields Continuing Resolution adopted without difficulty No Fed hike in 2017 because of trade conflicts New Fed Chair: change of course

Source: Rabobank Financial Markets Research

Conclusion

While Trump intends to give the US economy a much needed fiscal policy impulse, his protectionist course (especially in case of a trade war) may blunt the impact of this policy instrument. By the time he runs for re-election, four years may have passed without a serious effort to curb the unsustainable spending on entitlement programs and the rising public debt.

References

Richard Auxier, Len Burman, Jim Nunns, Ben Page, and Jeff Rohaly, An updated analysis of Hillary Clinton's Tax proposals, Tax Policy Center, Urban Institute & Brookings Institution, October 18, 2016 Len Burman, Jim Nunns, Ben Page, Jeff Rohaly, and Joe Rosenberg, An analysis of Donald Trump's Revised Tax Plan, Tax Policy Center, Urban Institute & Brookings Institution, October 18, 2016 Philip Marey, The Trump Trade War Game, Rabobank Financial Markets Research, 6 October 2016. Philip Marey, The US fiscal policy risk matrix, Rabobank Financial Markets Research, 26 May 2016. Philip Marey, Stefan Koopman, House of Cards, Rabobank Financial Markets Research, 13 August 2014. Philip Marey, Stefan Koopman, The Big Squeeze and the Republican Revolt, Rabobank Financial Markets Research, 23 February 2016.

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