The Economist: As the year of Trump begins, investors will finally get answers

For investors who bought on the rumour, it is nearly time to sell on the news.

They have spent months gripped by uncertainty over what America’s next president will do in office, as rumours have flown thick and fast.

How high will tariffs rise, and how strongly will other countries retaliate?

Will he really keep campaign-trail promises of mass deportations, sweeping deregulation or trillion-dollar tax cuts?

What will it all mean for growth, inflation and asset prices?

With Donald Trump’s inauguration on January 20, answers will at last start to arrive.

As to which rumours market participants have found most convincing, The Economist’s conversations with analysts, bankers and fund managers have yielded a number of common themes.

All of them expect at least some new tariffs; few have any idea where tit-for-tat retaliation might end.

None think a wave of mass deportations, and consequent shock to America’s labour market, is likely, though they worry that restrictions on future immigration might cause inflation to rise.

They hope that fiscal hawks in Congress and on Mr Trump’s economic team will keep America’s deficit, which is already at 6.4 per cent of GDP, from widening too much further.

Yet confidence on this is low, and a big fear is that additional borrowing might cause turbulence in the market for Treasury bonds, also destabilising other asset prices.

To see how investors are parsing these and other uncertainties, look at how markets are priced ahead of Mr Trump’s second term.

The most straightforward judgments come from currency traders, who are betting the dollar will remain mighty.

They have been bidding up its value relative to a basket of rich-world peers for months, but did so especially quickly after election night.

Meanwhile, the currencies of Mexico and Canada, on whose goods exports Mr Trump has threatened 25 per cent tariffs, have been hammered.

The foreign-exchange market, therefore, takes Mr Trump’s tariff threats seriously.

Traders expect exporters’ currencies to face less demand, as new levies raise the dollar prices of their goods.

They are also betting that the greenback will strengthen across the board — perhaps owing to its safe-haven appeal in a more volatile world, perhaps because blanket tariffs will induce Americans to send fewer dollars overseas.

At least for now, few believe that Mr Trump’s long-professed desire for a weaker dollar, to boost American exports, has much chance of being realised.

Stockmarkets offer more wide-ranging predictions.

The clearest is that American firms, in aggregate, are set to trounce those everywhere else, with share prices having risen by 3 per cent since Mr Trump’s election.

Although they have fallen a little over the past fortnight, investors still value listed American companies at multiples of their underlying earnings that have rarely been exceeded.

This is a clear bet on their continued ability to generate ever higher profits.

Compare that with the valuation multiples assigned to other big stockmarkets in Europe, Japan and Canada.

All are close to, or below, those assigned to American shares in late 2022, when the consensus view held that a recession was imminent.

America First, then — though investors have been discriminating about precisely which industries will race ahead.

Since Mr Trump’s re-election share prices have diverged.

The winners by some way have been “consumer discretionary” firms, including Amazon and Tesla, which do well when shoppers have spare income.

Their success suggests shareholders are counting on Mr Trump to keep wallets bulging, perhaps by extending cuts to personal-income tax made in his first term.

(Tesla’s investors probably also owe much to the friendship of its boss, Elon Musk, with the president-elect.)

Shares in IT and financial firms, likely to face lighter regulation, have also done well.

The losers include industries that Mr Trump has seemed to favour.

His promise to “drill, baby, drill” has not buoyed oil and gas firms, whose production is constrained by low oil prices rather than a lack of permission to drill.

Nor has his former career in real estate boosted that sector; it has been hit by higher borrowing costs from rising bond yields.

Share prices for materials firms, which rely on imported commodities and machinery that may soon be subject to higher tariffs, have slumped.

With share prices still rising overall, none of that will much bother Mr Trump.

Instead, if he is to face trouble from the markets, it is most likely to come from Treasury bonds.

Their yields have already climbed, with the ten-year borrowing cost now 4.6 per cent, up from 3.6 per cent in September.

One big fear is that the inflationary effects of policies Mr Trump has proposed, such as tariffs and reduced immigration, will force the Federal Reserve to keep interest rates high.

Another is that fiscal laxity will lead to bumper Treasury issuance, forcing prices down and yields up.

One way of gauging these fears is to examine the “term premium” on government bonds.

This is the component of borrowing costs that is not attributable to expected changes in the Fed’s short-term interest rate.

In other words, it is the extra yield investors demand above the risk-free rate as compensation for the chance that government-bond prices crash — in response to high inflation, say, or unsustainable borrowing.

Roughly 80 per cent of the recent increase in Treasury yields has come from a rising term premium.

None of this suggests that government-bond yields are about to soar, a prospect that even the most nervous market participants think unlikely.

More plausibly, having spent so long trying to guess what the next four years will hold, investors will shortly have a shot at influencing the answer.

A turbulent Treasury market would be sure to hit share prices, a measure of presidential success that Mr Trump famously holds in high regard.

Whether or not bondholders have listened to the right rumours, if enough of them start selling on the news, expect the news to change.