The new US president

With such a convoluted political system at play in the US, the importance of the president to the financial markets shouldn’t be overstated. 

For all Trump’s bravado in the run up to his inauguration – and the Republicans’ coup in securing both houses of Congress – any legislation of concern to traders will still have to jump through a number of hoops before it risks disrupting the markets. This may go some way towards explaining why Trump’s election victory did not bring about the market meltdown many commentators had predicted.

That said, his plans to cut tax, deregulate industry, ramp up spending and renegotiate trade deals make Trump more likely to have a significant market impact than many of his predecessors. So what might his policies mean for traders?

Tax

The number of income tax brackets will fall from seven to four. Rates for those in the higher brackets will be reduced, and the lowest earners will pay no tax at all. Corporate taxes will be scaled down by half, though certain exemptions that are currently available will disappear. Trump claims that a more generous system will encourage domestic investment from American companies – who are withholding an estimated $2 trillion in profits overseas – and discourage tax avoidance.

What could the market impact be?

Reducing taxes could give certain corporations’ values a shot in the arm, and in turn lead to higher stock prices – particularly for those companies currently not favoured by tax laws. And if it increases spending, it could also be positive for the US economy, in turn causing the dollar to rise.

But any positive impact from Trump’s tax policy may already be priced in by the markets, with potential downside movements if there is any sign of delays, or dilution, of tax reforms.

Key market to watch: US indices. Between 1929 and 2011, US indices gained more under Democrats than Republicans. Will Trump buck the trend?

Spending

Trump has stated that he will not revisit major entitlement costs, such as social security and Medicare. And with no concrete plans for how he’ll replace Obamacare – as well as promises to ramp up spending on infrastructure and defence – spending during Trump’s time in charge looks set to skyrocket.

To counteract this, he has announced four main proposals to reduce spending: 

• Scale back federal programmes, notably those associated with the Department of Education and the EPA
• Renegotiate government contracts 
• Sell off government assets 
• Cut out ‘waste, fraud and abuse’

What could the market impact be?

Promises of more spending were probably the biggest reason why US markets rallied after Trump’s election victory. By injecting more capital into the economy, Trump could offer a serious boost to US businesses and the dollar. 

However, if national debt starts growing at a problematic rate then his spending plans could quickly turn sour. With Republicans often reluctant to sanction spending increases, and Trump himself reluctant to discuss the subject in the run up to his inauguration, this may be one of the policies he is more flexible on. 

Key market to watch: Bonds. Fiscal policy can have a major impact on bond markets, so bond investors will be closely watching any developments on Trump’s spending plans.

Trade

Free trade agreements NAFTA and the Trans-Pacific Partnership will be renegotiated or dismantled. Far more stringent tariffs could be exerted upon Mexico and China (35% and 45% respectively) unless they comply with Trump’s terms, with a view to boosting domestic manufacturing. 

What could the market impact be?

The potential market impact of Trump’s trade plan is complicated. Moving away from free trade will mean paying more for imported goods, which means inflation. With inflation falling far behind targets for some time, that would be welcomed by many – as long as the Federal Reserve is able to adapt its policy in time.
But elsewhere, restrictions on trade could cause problems. We have already seen Trump’s bravado negatively colour foreign relations with key trading partners – in particular China. There is now a real worry that he could be paving the way to a full-blown trade war.

Key markets to watch: The dollar. Rising inflation, domestic manufacturing, or hostilities with China would all have a major impact on US dollar crosses.