Thursday, December 8, 2016

We’ve discussed previously the uncertainty around the impacts of the U.S. election and the course of U.S. policy. However, recent personnel announcements and public statements by the President-elect are starting to fill in the picture; we’ll know more as the new Administration prepares to take office on January 20th, 2017. In the meantime, IIF experts weigh in below with their personal predictions on some of the likely impacts of the Trump Presidency.

Latin America: Bracing for Trump Headwinds

Ramon Aracena Chief Economist Latin America

By: Ramon Aracena, Chief Economist, Latin America

We expect weaker regional growth in 2017 as a consequence of the shift in U.S. policies. Uncertainty over Trump policies has already weakened currencies and delayed investment. The intensity of spillovers on each nation is inversely correlated with their degree of trade integration with the United States. Mexico and the Pacific Alliance block (Chile, Colombia, Mexico and Peru) are the most exposed to trade protectionism as the U.S. accounts for 80% and 60% of their exports, respectively. All of these countries have free trade agreements with the U.S. that could potentially be revised.

This adverse impact via trade will be exacerbated by rising external financing costs and weakening confidence. A policy mix in the U.S. that leads to faster monetary tightening by the Federal Reserve will increase foreign currency borrowing costs, while a decline in business confidence will deter fixed capital investment. Currency depreciation pressures will introduce a tightening bias on monetary policy, undercutting growth. Mexico’s central bank has hiked its policy rate twice and others may have to slow the pace of monetary easing (e.g. Brazil).

Trump’s policies could also have an unwanted political effect. By weakening the capacity of the region to grow, they could undermine the appeal and influence of pro-market political forces, increasing the risk that failed inward-oriented growth strategies and political instability will reappear. The region’s challenge is to look out, not in. The flexibility of regional economies must be enhanced to facilitate adjustment to what could be a tectonic shifting of the global economy.

Latin America Market Share


Drill Baby, Drill

Ulrik Bie Chief Economist

By Ulrik Bie, Chief Economist, Global Macroeconomic Analysis

If the incoming administration follows through on its promises, U.S. long-run oil production capacity will be boosted, reinforcing the role of the U.S. as a swing producer and reducing OPEC’s ability to raise prices by holding back its own production.

Shale producers have been able to increase oil production massively based on new fracking and horizontal drilling technology—U.S. oil production is up 75% since 2008. Trump will only accelerate the trend. He has promised to allow for more drilling on federal lands. He’s also likely to revisit Obama’s five-year ban on new oil and gas drilling in Alaska (where production has been declining since the 1980s) and off the Atlantic coast. Furthermore, he’s promised lighter environmental regulation, which would reduce compliance and transportation costs—and thereby breakeven prices.

Domestically, the shift from coal to natural gas is likely to continue, notwithstanding Trump’s strong appeal in coal country based on his commitment to lighter environmental regulation. Natural gas output is up 41% since 2008 and prices are now down 36% on average. Natural gas has now replaced coal as the dominant fuel in power production and this shift is unlikely to reverse.

US Energy Production

Trump Tax Cuts: A New Game in Town

Charles Collyns Managing Director and Chief Economist IIF

By: Charles Collyns, Managing Director and Chief Economist

The new president will work closely with a Republican-led Congress to deliver a major tax cut—larger than Bush in 2001 and perhaps the largest since the early days of the Reagan Administration.

A sharp reduction in the corporate tax rate as well as in personal income tax rates will be wrapped in tax reforms including some base broadening measures. There could also be some measures to control public spending—although more money has been promised for defense and infrastructure. The overall impact of the Trump package is likely to be a substantial fiscal stimulus starting in the second half of next year, growing in to 2018, a sharp shift from the fiscal restraint that has prevailed in Washington since the immediate post-crisis stimulus.

To be sure, many have been arguing—from the center and left as well as the right—for a macro policy reset: more fiscal support to the economy to allow the Federal Reserve to normalize its policy stance more quickly. Indeed, markets are now anticipating significantly more rapid increases in the Fed’s policy rate than before the election, reducing concerns about financial stability from ultra-low rates.

But two concerns loom large. One is how far the tax cuts will actually benefit the middle classes under stress, as opposed to high-income earners, and boost sagging business investment and GDP growth. And second is whether generous tax cuts will undercut long-term fiscal sustainability, with Federal government debt already around 105% of GDP—far higher than at the time of the Reagan or Bush tax cuts.

US Fiscal Balance

Emerging Asia: Navigating Testing Times

Bejoy Das Gupta, Chief Economist, Asia-Pacific

By: Bejoy Das Gupta, Chief Economist for Asia/Pacific

Economic policies of the Trump Administration could negatively impact Emerging Asia through both the trade and finance channels, although there are robust buffers. Trump’s anti-trade rhetoric has so far focused on China and Mexico along with possible punitive tariffs on U.S. companies shifting production and jobs abroad. The resulting uncertainty could hurt global supply chains and trade. In Emerging Asia, Malaysia and Thailand are the most exposed, followed by Korea, with exports having a large share of GDP and the U.S. directly accounting for a sizeable part. India, Indonesia, and the Philippines, being less trade dependent, are less exposed. Overall, the downside should be limited, as Emerging Asia is relying more on domestic demand and intra-regional trade to bolster growth.

Turning to the finance channel, the region benefits from current accounts in surplus or small deficits, and, therefore, is less exposed to an export slump sharply raising the external financing requirement. However, non-residents have sizeable holdings in regional securities markets, which are also quite liquid. In anticipation of U.S. fiscal stimulus and monetary tightening, there has already been a foreign sell-off of the region’s equities and bonds in November. Looking ahead, the changed U.S. policy mix raises the possibility of periodic volatility in the region’s financial markets, with countries with greater foreign portfolio holdings more at risk. Nevertheless, positive growth, relatively attractive valuation and yield differentials would suggest that the region should continue to attract substantial non-resident capital inflows, especially for countries with supportive reforms and politics.

EM Asia Export and Trade with US

Mixed Bag for Tech

Conan French - IIF

By: Conan French, Senior Advisor, Innovation

The U.S. technology sector will feel a strong shift as the Trump Administration takes office and many of the conditions that enabled its global ascent are less assured. Changes to their operating environment—free access to open markets, the ability to attract foreign talent, and close alignment and affinity with the public sector—could disrupt a sector used to being the disruptor.

U.S. tech firms have attracted top data engineering talent from around the world and rely on these minds to propel their companies in a global marketplace. Changes in immigration policy, or just perceptions, could hit the bottom line.

Tech would be particularly vulnerable to the trade disruptions. Digital products and platforms are inherently global and scalable as long as there is free and open access to markets. They have reaped outsized returns from these conditions so fracturing markets could have a disproportionate impact.

A minimalist approach to regulation by a Trump Administration would be a positive and allow the industry to keep developing new products and services in the U.S. market, even if others are more complicated.

The change in connectivity and culture between Silicon Valley and Washington could be stark. Google’s Erik Schmidt had 427 meetings with the Obama White House and that level of affinity permeated the industry and the government. Peter Thiel will represent the Trump transition at a meeting with the major tech firms the week of December 12, but this is a slim starting point for an industry used to being intertwined with policy makers.

Financial Markets: Hope for the Best—and Prepare for the Worst

By: Sonja Gibbs, Senior Director, Global Capital Markets

While awaiting specifics on policy priorities under the new Trump Administration, investors have been guided by three basic assumptions: 1) a hefty dose of fiscal stimulus via tax cuts and infrastructure spending (stronger U.S. growth, higher inflation and higher bond yields); 2) tighter monetary policy (stronger U.S. dollar, more upward pressure on yields); and 3) a rise in global trade tensions (problematic for emerging markets, especially coupled with rising U.S. rates). With the recent OPEC deal lending still more support to a broad global reflation theme, markets have repriced accordingly—in favor of U.S. cyclical stocks and financials, and against bonds, emerging markets, and most non-U.S. currencies.

Indeed, proposed U.S. corporate tax cuts (and more pricing power due to higher inflation) could boost profit margins and earnings—a welcome improvement from recent sub-par growth. Even without multiple expansion, with the S&P forward P/E ratio staying near its current 17x, U.S. equities could see gains on the order of 5-10% if large tax cuts do materialize (although tax reform could also eliminate many business tax credits and allow fewer interest expenses to be deducted). A push for deregulation could add to market gains, particularly for financials and energy.

However, while the “Trump trade” could have further to run, policy uncertainty and implementation risk are high. A more aggressive Fed and dollar strength could curb stock market gains, while the rise in U.S. bond yields may be dampened by demand for high-yielding, safe-haven assets. The deflationary global debt overhang hasn’t gone away, either—nor has China currency risk. Finally, while fully acknowledging the risks for emerging markets, bargain-hunters may be (selectively) tempted by lower valuations and cheaper currencies—particularly given that many investors were underweight EM even before the recent selloff.

assest movements post us election

Trump’s Iran Policy

Garbis Iradian

By: Garbis Iradian, Chief Economist, Middle East and North Africa

During the campaign, Trump said that his “No. 1 priority is to dismantle the disastrous deal with Iran.” His transition team has started preparatory work on new sanctions, which could include measures that focus on Iran’s ballistic missile program and its support of militant proxy groups in the MENA region (including in Yemen, Syria, Iraq and Lebanon). Reimposition of secondary sanctions in the U.S. could punish any foreign company or country trading with Iran by denying them access to the U.S. market, including financial services. But sanctions on U.S. dollar payments make Iran’s oil exports firmly China/India bound and gives them an advantage in terms of imports and investment.

Although the U.S. could reinstate UN sanctions by invoking the “snapback” provisions in the deal, this would be very risky. Other UN members might not enforce the sanctions, and Iran would almost certainly take the opportunity to walk away from its obligations under the deal.

Also, if the nuclear deal is undermined it could strengthen the position of hardliners, including the elite Revolutionary Guards, and damage Rouhani’s (the moderate president) prospects of being re-elected next year. Such an outcome would make the regional conflicts more entrenched and raise the risk of war with Israel.

Ultimately, the Trump Administration may find the deal hard to unwind, and Iran may find elements to support in a Trump Administration. His “America First” slogan (isolationism), if implemented, would give Iran a level of comfort. Second, improvement in the U.S.-Russia relationship could mitigate the risk of an escalation in tensions between Iran and the U.S. Third, fighting ISIS is likely to be first priority in the Middle East.

Iran Imports of Goods

China: A More Hostile Environment

Gene Ma Chief Economist

By: Gene Ma, Chief Economist, China

Trade frictions are likely to rise in the coming year, particularly in sectors where Chinese exports hurt U.S. Rust Belt states. On the campaign trail, candidate Trump threatened to declare China a currency manipulator and to impose a 45% punitive tariff. The next Treasury report on currency issues is due to Congress in May.

Beijing has seen itself as the victim of the strong dollar and soft peg in the past few years. Though down 7% from its 2015 peak, the RMB is still 12% stronger in real effective terms than it was four years ago. The PBoC has used close to $700 billion in reserves since July 2014 to prevent the RMB from further depreciation.

It is true that China runs a huge trade surplus with the U.S., at $260 billion in 2015 ($365 billion if Hong Kong is included). However, this is in part because China serves as the final assembly point for global exports to U.S. consumers. China runs trade deficits with some countries providing materials and components. Combined with a large deficit in services ($182 billion in 2015), China’s current account surplus in 2015 was only 3% of GDP, well below those of Germany and Korea.

China’s direct investment into the U.S., which has ballooned in recent years, will also face a more hostile environment. China is likely to react by threatening U.S. companies that export to or operate in China. This could do considerable damage to supply chains and U.S. corporate interests. And financial markets are likely to be quite sensitive to signs of misunderstanding and miscalculation by the two countries, not only on the economic but also the strategic front, with the early December phone call with Taiwan as a recent example.

Europe: No Respite from Fiscal Realities

Peter Nagle, Economist, Global Macroeconomic Analysis

By: Peter Nagle, Economist, Global Macroeconomic Analysis

Trump’s economic plans provide additional uncertainty for euro-area policymakers. The appreciation of the dollar following the election, together with Trump’s proposed fiscal stimulus, could benefit the euro area by increasing demand for its exports. That would boost GDP growth, taking some of the pressure off the ECB (assuming no shift in U.S. trade policy against European exports). The rise in bond yields following the U.S. election has also alleviated concerns about scarcity of bonds eligible for purchase.

A large stimulus in the U.S. would increase calls for a change in the European macroeconomic policy mix. Overall, the euro area is in a better fiscal position than the U.S., with a smaller fiscal deficit and lower debt-to-GDP ratio. Indeed, the European Commission recently suggested a modest fiscal expansion in the euro area would be desirable. But the problem is that countries with space, namely Germany, are reluctant to spend more, while the fiscal situation in others, such as Italy and France, is constrained. The fiscal challenges from ageing are also much larger in the euro area, so a stimulus—on any scale—remains unlikely. Trump’s calls for all NATO members to increase defense spending to meet the 2% target will therefore prove tricky for the euro area, with most countries currently well below target. Spain and Italy in particular will find it hard to satisfy both the NATO requirement and the requirements of the Stability and Growth Pact. Expect heated budgetary discussions with the European Commission to continue.

Euro Area Government Debt to GDP Ratios

Regulatory Policy: Less International Engagement, Lighter Tone

Andres Portilla - IIF

By: Andrés Portilla, Managing Director, Regulatory Affairs

The Trump Presidency will have significant implications for financial regulatory policy, both in the U.S. and internationally. Although specific details have not yet been defined, we will see a policy shift towards less financial regulation in the U.S. based on statements from President-Elect Trump, his recently nominated officials and Republican Congressional leaders.

The new Administration and its agencies will likely be much less engaged in international policy making and standard setting. Implementation of global standards is going to be the object of greater skepticism and U.S. “specificities” will be much more present in global negotiations and local implementation of global standards.

The Administration and Congress will also target the Dodd-Frank Act for revision, though the extent to which it will be changed is unclear at this point. Some areas that will see likely changes will be the Volcker Rule, structural changes to the Consumer Financial Protection Bureau, and Dodd-Frank’s SIFI designation thresholds, which are likely to be increased, reducing the number of banks subject to such designation.

The FSOC and other agencies are also likely to be less prone to designate new firms as “systemically important”—particularly asset managers and others not yet subject to such designation.

Along with new faces—including two new Federal Reserve Governors, a new Fed Vice Chair for Regulation and new heads of the SEC and CFTC, among others—the industry will hear a new, lighter, regulatory “tone” from Washington D.C.

Emerging Europe Sizes Up the Trump Presidency

Ondrej Schneider, Chief Economist, Emerging Europe

By: Ondrej Schneider, Chief Economist, Emerging Europe

Countries in Emerging Europe look at the new Administration with very different expectations. Russia is hopeful that the Trump Administration will be friendlier towards it and will dilute or even cancel sanctions that were imposed on Russia after the annexation of Crimea in 2014. Russian financial markets jumped immediately after the election was called for Trump, as major energy companies and state-owned banks currently banned from raising longer-maturity debt from the U.S. markets would stand to benefit most from lifting the sanctions. Even if financial sanctions are not lifted, Russian firms may hope for more leniency in imposing the U.S. ban on exports of dual use technology. A more forbearing approach by the new Administration would help lift Russia’s growth rates from the current dismal 0-1% potential. More importantly, it would allow President Putin to pronounce himself a winner in the stand-off with the Western powers before the presidential election in 2018.

Authorities in Ukraine fear that more amicable U.S.-Russia relations will undermine U.S. support for their reform process. The U.S. has been a steadfast ally since the Maidan revolution in 2014 and it has helped finance the new government by guaranteeing its international bonds and supporting the IMF program in Ukraine.

By contrast, Central and Eastern Europe (CEE) is less exposed to changes in U.S. policies. The European Union provides a firm anchor for the CEE region, receiving 50-80% of their exports and providing the dominant share of external financing, either via the EU budget or private capital flows. Their main concern is geopolitical—the consequences of a more aggressive Russia and at the same time rising populist forces in Western Europe that could undermine commitment to the European project.

Hints of U.S. Realignment

Kristen Silverberg - IIF

By: Kristen Silverberg, Managing Director

The Trump Administration will test the durability of some of America’s longstanding alliances, but may create opportunities for new cooperation with others.

On the one hand, the President-elect is committed to further downsizing America’s role in the world and ascribes to a narrower view of U.S. interests than his recent predecessors. His national security strategy will focus on the fight against terrorism, the theme of a book published by his National Security Advisor, General Michael Flynn: “The Field of Fight: How We Can Win the Global War Against Radical Islam and Its Allies.” The potential for cooperation on terrorism will reinforce Trump’s instinct to find a new accord with Russia and create opportunities for closer ties with Egypt and Turkey. At a rally in Ohio in early December, Trump reiterated his willingness to “partner with any nation that is willing to join us in the effort to defeat ISIS.”

However, his views on climate change, NATO, the EU, civil liberties and enhanced interrogation will strain the relationship with allies in Europe. Trump’s opposition to the Trans-Pacific Partnership, the 12-member trade deal with Asia, will make engagement with partners in Asia more challenging and create opportunities for China to fill the space with its own regional trade agreement. Although U.S.-China disagreements around trade and investment issues are inevitable, the U.S.-China relationship is unlikely to produce major clashes in the short-term, in part because Xi would like to get through the party conference in October without a blowup. The longer term relationship is anyone’s guess, though China will be reassured by the more restrained U.S. role on global issues and Trump’s apparent lack of interest in promoting democracy overseas.

U.S. Infrastructure Investment: Needed—But How?

Hung Tran Executive Managing Director IIF

By: Hung Tran, Executive Managing Director

The President-elect and his team have floated a number of ideas, including financing $1 trillion in infrastructure spending via $137 billion in tax credits and a U.S. infrastructure bank. In addition, to upgrade infrastructure sufficiently to raise the U.S. potential growth rate would require appropriate federal budgetary outlays. Such funding could be done through issuance of long-term bonds, taking advantage of historically low interest rates and earmarking portions of the expected tax revenue on repatriated cash held overseas by U.S. companies. The new Administration’s infrastructure strategy is therefore likely to involve some form of tax credits and direct outlays from the federal budget; an infrastructure bank is also a possibility, though it would face difficult governance challenges.

Infrastructure strategies need to be focused—or risk being dissipated in a wide range of competing ideas, with none achieving enough critical mass to have any impact. The President-elect has often referenced the need to remedy the serious deterioration of U.S. physical infrastructure (estimated by the American Society of Civil Engineers to require $3.6 trillion); finding funding for transportation projects is likely to be an early priority. The Trump team has also stressed the need to upgrade the public digital infrastructure (including the digital highway, connectivity and bandwidth capabilities)—and address the cybersecurity risks facing critical utilities installations. Hence U.S. digital infrastructure may also be front and center.

Global Transportation Infrastructure Spending by Country

U.S.-Turkey Relations to Improve Under the Trump Presidency

Ugras Ulku - IIF

By: Ugras Ulku, Senior Economist, Emerging Europe

Turkey has been one of the countries most affected by diminished EM investor appetite since Trump’s election victory and the associated expectations of a macro policy shift in the U.S. The ongoing lira weakness prompted the Turkish central bank to hike its short-term interest rates in November, but investors remain concerned by Turkey’s large external funding needs and a perception that the Erdogan Administration will revisit needed policy corrections.

Against this, Turkey may benefit from improved diplomatic relations with the U.S. In the run up to the U.S. elections, several factors have brought the U.S.-Turkey relations to historic lows, including Hillary Clinton’s statement that, in the fight against the ISIS, she would consider arming the Kurds, and stalemate over the extradition of Fethullah Gulen, the Pennsylvania-based preacher who many in Turkey believe staged the July coup attempt.

Political leadership in Turkey is optimistic about starting with a clean slate for U.S.-Turkey relations under the Trump presidency. President Erdogan and the AKP leadership believe that the American establishment—in both the Democratic and the Republican parties— was overly critical of what has come to be known as Turkey’s authoritarian turn, but that Trump will be more open to closer ties. Indeed, General Michael Flynn, President-elect Trump’s pick for National Security Advisor, had previously served as an advisor to the Turkish Government.

IIF Authors

Ramón Aracena

Chief Economist

Ulrik Bie

IIF Ulrik Bie Chief Economist
Chief Economist

Charles Collyns

Charles Collyns Managing Director and Chief Economist IIF
Managing Director and Chief Economist

Bejoy Das Gupta

Bejoy Das Gupta
Das Gupta
Chief Economist

Conan French

Conan French - IIF
Senior Advisor for Innovation and Fintech

Sonja Gibbs

Sonja Gibbs Senior Director Global Capital Markets IIF
Senior Director, Global Capital Markets

Garbis Iradian

Head of MENA Research

Gene Ma

Head of China Research

Peter Nagle

+1 202 857 3313

Andrés Portilla

Andres Portilla - IIF
Managing Director, Regulatory Affairs

Ondrej Schneider

Head of EM Europe Research

Kristen Silverberg

Kristen Silverberg - IIF
Managing Director

Hung Tran

Hung Tran Executive Managing Director IIF
Executive Managing Director

Ugras Ulku

Deputy Head of EM Europe Research