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Trumpflation Expectations

T Minus 49: Countdown to Trumpocracy

Don Curren December 2, 2016

Whatever else it unleashes, the Trump era has given us a multitude of amusing new words.

It turns out you can stick almost any suffix on the end of Trump sounds funny, scary, or both. Trumpaggedon, Trumpocalypse, Trumpocracy, Trumpnado, and Trumponomics – the list goes on and on.

“Trumpflation” is a particular favorite in financial circles.

Trumpflation is the resurgence in inflation many analysts expect to come as stimulus spending promised by Trump heats up the U.S. economy.

Trumpflation, of course, is not a real phenomenon – at least not yet. But it’s having a real impact on financial markets. The selloff in bond markets after Trump’s election win is at least in part attributable to concerns about resurgent inflation.

There have been many “—flation” scares since the global financial crisis, of both the “in” and the “de” variety. The most memorable was the chorus of inflation worries that greeted the U.S. Federal Reserve’s initial Quantitative Easing program in 2010.

Many economists argued pumping money into the financial system by buying bonds from banks, the essence of the Fed’s QE program, would uncork the bottle and let the inflation genie out.

It didn’t happen. In general, deflation has been a bigger concern for economies across the globe in the last few years of sluggish growth.

It’s tempting to think “Trumpflation” will be another false alarm on the inflation front. And that may prove to be the case – we don’t know what Trump’s policies will be. Connecting likely policy developments with campaign rhetoric, always a tricky thing to do, is especially problematic in Trump’s case.

The president-elect has expressed an intention to launch some stimulative measures that could rev up the U.S. economy and put upward pressures on prices. The Trump transition team’s website says his administration will seek to invest US$550 billion on transportation and other forms of infrastructure.

Tax cuts would also be stimulative, but again, it’s not clear how much of Trump’s proposed tax cuts will see the light of day.

It’s also not known how these policies will play out in an economy that’s already well into an expansion, albeit one supported by unprecedented monetary stimulus from the Fed.

The net effect of his policy mix, whatever its specifics look like, will be likely be stimulative to some degree.

“Even if the legislation to emerge from Congress is more moderate, as seems likely, a big dose of tax cuts and new spending appears to be in the offing,” is how the Economist puts it.

But fiscal policy alone is not the only potential trigger for inflation in Trumps’ platform. Other policy priorities, including his stances on immigration and trade, have the potential to ignite higher levels of inflation.

“Donald Trump is inflationary. Most elements of his economic policy have the potential to ignite inflation well above what is currently priced in,” CIBC Deputy Chief Economist Benjamin Tal said in a recent report.

Take Trump’s desire to expel illegal immigrants. Again, the number of people who be affected is uncertain at this point. But the U.S. labor market is near full-employment, and a substantial reduction in labor supply could lead to an increase in the bargaining power of existing labour, which would in turn engender inflation, said CIBC’s Tal.

Trump’s trade policies could also come into play here. “If globalization and free trade were major disinflationary forces, then any increase in protectionism must be inflationary,” Tal said.

If Trump were to impose a 15% tariff on both Mexico and China, a move would not need a congressional approval, the overall price of imported goods in the U.S. would rise by approximately 5%, Tal said.

Of course Trump’s potentially inflationary policies will not be working in isolation. The U.S. Federal Reserve is expected to raise interest rates next month, and could follow through with additional tightening.

So the Fed could be working to cool off the U.S. economy – and thereby inflation – while the White House is stoking it up.

How much inflation it will add up to is anyone’s guess. But it’s a possibility investors and businesses should take into account.

If inflation fails to manifest itself, the U.S. dollar strength that’s emerged as a dominant currency market theme since the election in the U.S. will be at least partially reversed, likely generating heightened turbulence in foreign exchange.

Investors and corporations need to be cognizant of the inflation risk – and of the uncertainty surrounding it.  Even if there is no inflation, unwinding the inflation expectations already priced into asset markets could create volatility.

In short, we should all be exercising some “Trump-prudence, “ as it were, about the possibility of inflation in the coming weeks.