Central banks have dominated the world of global finance since the financial crisis began eight years ago, so much so that one analyst calls it a “one-factor world,” with liquidity swamping everything else. But that could be about to change, says Michael Medeiros, vice-president, global bond strategist, with Wellington Management Company.
In the U.S., for example, President Trump’s policies can be divided between two buckets: reflationary and protectionist. The reflationary bucket represents the biggest fiscal stimulus ever at a time when the economy has reached full employment.
“He’s proposing really big changes from what we’ve seen in the last eight years in the U.S.,” Medeiros explains. “We’ve seen lower government spending, higher taxes and more regulation. Trump proposes to flip all three of those on their heads.” All told, they could represent a stimulus of 2 percent of GDP. Tax cuts, however, are likely to have only a short-lived effect. The two biggest stimuli would be greater infrastructure spending and tax reform.
On the other hand, deregulation, too, could have a significant impact. “A big part of Trump’s agenda is deregulating the financial sector, less through legislation, which is tough to do, and more through enforcement,” says Medeiros. “Even if he keeps the amount of regulation the same, that could theoretically unleash the lending channel in the U.S., which has been absent since the financial crisis.”
Good Inflation or Bad?
With the economy at full employment, he adds, “it’s a question of whether it’s good inflation or bad inflation. Is it good inflation because you’re growing above trend, or is it bad inflation because trend growth is collapsing? On that point, Trump’s policies are a bit mixed. On the tax side, even if the administration gets just a third of what it wants for tax reform, that would still add a percentage point in growth in the U.S. next year.”
But Trump’s policies on the protectionist side could potentially undercut this. “The impact of protectionism is not only through trade,” Medeiros explains. “There are outright tariffs. I think if Trump really wants to keep growth going, he won’t do that. There are also trade restrictions and modifications, which he could easily do — and then there is the border adjustment tax as well, which can be a form of protectionism. Such measures would weaken global growth and restrain inflation.”
Another aspect is labour regulation. “The U.S., like a lot of countries, is under a demographic headwind. The percentage of the population of working age should slow over the next 10 years, but immigration is an important source of such growth. It’s about half of the contribution to the labour component of trend growth, so, in restricting that, you get higher inflation — but it also comes at the cost of lower trend growth.”
While Canada is likely to benefit from an inflationary upswing in the U.S. — if it flows through to goods rather than to services — Japan and Europe are following different paths. As a result, the world economy becomes less dominated by central bank policy or the “one-factor world,” he says. “For us, the divergence in world economies and central bank activity helps expand the global opportunity set. Country differentiation at the macro level can be net positive.”