The biggest transition in the current environment is a shift away from the dominant trend of globalism, which brought increased cross-border flows of goods and people. After years of slow economic growth and rising wealth inequality, support for parties with more populist messages—often focused on easier fiscal policy, immigration reform and/or protectionist trade policy—has been rising steadily over the past few years.
Populism claimed two major victories in 2016 with Britain’s decision to leave the European Union and the election of Donald Trump as president of the United States. In 2017, we will be closely monitoring the strength of the populist trend given its potential to impact Europe and the increased likelihood of more protectionist trade policies.
Key Political Events We’re Watching in 2017
Trump's First 100 Days
The balance and composition of Trump’s policy agenda between stimulus, trade, immigration and foreign policy is still largely unknown and hard to generalize, and therefore leads to a wide range of macroeconomic and market outcomes.
—Neill Nuttall, Co-CIO, Global Portfolio Solutions
We think a change in the US policy regime will have many cross-currents for investors to consider. An agenda emphasizing fiscal spending, tax cuts and de-regulation will likely spur economic growth, inflation and higher interest rates. On the other hand, the potential for increased protectionism and tighter immigration may constrain long-term economic growth, while also contributing to higher inflation.
The Trump administration’s agenda during the first 100 days will be critical to gauging its priorities and preferences on trade, regulation, fiscal stimulus and monetary policy over the rest of the year. More emphasis on fiscal spending and de-regulation could generate both growth and inflation, whereas an emphasis on trade tariffs might bring more inflation than growth (see “Stagnation to Inflation”). Regulatory changes might first affect industries such as finance, energy or healthcare, but could gradually impact much larger parts of the economy as effects pass through to businesses and consumers (see “Regulation to De-Regulation”). Tax cuts could have a more immediate broad-based effect on the economy, but the impact could be limited if inflation continues to rise and the Federal Reserve (Fed) becomes more hawkish (see “Monetary to Fiscal Policy”).
With the US becoming more of a driver of global policy uncertainty than a stabilizer, we think the range of potential scenarios has increased. Markets have moved to price in stronger growth, higher inflation risk and high expectations for de-regulation. We see a risk that the market may be underestimating the potential negatives of protectionist trade policies, where the president has more discretion, and overestimating the positives of tax cuts and fiscal spending, which require more difficult congressional approval. The interplay between fiscal and monetary policy will also be important in gauging the overall impact of Trump policies and the implications for interest rates, risk assets and volatility.
Markets Appear to be Priced for Benign Scenarios Despite Policy Uncertainty
Source: Bloomberg. Baker, Bloom & Davis. As of Dec. 6, 2016. The Global Economic Policy Uncertainty Index is a GDP-weighted measure of news references to policy uncertainty. The VIX Index is a measure of S&P 500 implied volatility.
The populist push is forcing mainstream parties to listen to people’s concerns about globalization, immigration and austerity. We think a Eurozone break-up scenario is unlikely in 2017, but we do see the potential for Trump-like policies in terms of trade, taxes and infrastructure spending.
—Alexis Deladerrière, Portfolio Manager, International and Global Equity
Populism has infused both right- and left-wing parties in Europe over the last few years, largely fueled by Eurosceptic, anti-austerity and anti-immigration sentiment. Populist impact on policy has been limited because mainstream parties remained in power. Now, populist victories in the UK referendum (Brexit), the US election (Trump) and Italy (the defeat of the constitutional referendum) are putting increased focus on 2017 national elections in France (April/May), Germany (September– October) and the Netherlands (March).
The potential for real populist influence at the national level—whether through additional parliament seats, partnership in a coalition government or a national leadership position—will be an important gauge of the strength of the populist movement. It could have implications for broader European policy, the economy and the Eurozone itself.
We think the potential for meaningful populist gains in core European countries may present the biggest potential risk of a significant market inflection point in 2017. European cohesion already appears fragile, particularly following the UK referendum. Concerns about a Eurozone break-up could lead to stalled businesses and investment decisions while driving increased volatility in financial markets. Populist outcomes in other countries are also likely to meaningfully impact European financial markets. If US policy leads to fiscal spending but also protectionism, the result may be higher inflation, rising interest rates and a stronger dollar, all of which may pressure emerging markets, which are important end markets for many European companies. At the same time, European companies with business lines in the US may benefit from these conditions.
Europe’s Non-traditional Parties are Gaining Power
Source: http://www.parties-and-elections.eu/, and GSAM. As of November 2016.
Trade protectionism poses a downside risk to China’s growth, mainly via indirect effects on investment and the labor market. A strong desire for stability ahead of the upcoming political transition suggests the government will respond, leading to worsening imbalances.
—Prakriti Sofat, Emerging Markets Economist, Global Fixed Income
Trade policy was a major focus of the Trump campaign and is an area where the president has significant discretion. As a result, even if the Trump administration takes a softer line in many areas relative to campaign rhetoric, we expect the administration to follow through on pledges to take a tougher line on trade, with focus on country and sectorspecific trade imbalances. By country, the US’ largest goods trade deficits are with China, followed by the rest of Asia, Mexico and to a lesser extent Western Europe. By sector, the deficits are largest in technology and related products, motor vehicles and apparel. If policymakers are to focus on country-sector combinations, computers from China account for the largest goods trade deficit, making the country a notable target for trade action.
Emerging economies that have benefitted from global trade are likely to see growth headwinds, notably in China and Mexico. China is likely to respond to growth pressure with additional credit growth and fiscal stimulus focused on infrastructure given a strong desire for stability ahead of the Communist Party Congress in the fall of 2017. As a result, China’s imbalances could worsen, which could prompt capital outflows and renewed concerns about the country’s growing debt. In Mexico, where the economy has already shown signs of slowing, trade uncertainty acts as another headwind.
The aggressiveness of US protectionist measures will also be an important indicator of the potential for retaliatory tariffs on US imports. Retaliatory tariffs by China may be less effective because US exports to China are not as great as Chinese exports to the US. Still, tariffs would put upward pressure on the price of imported goods and could contribute to higher inflation, adding to the case for Fed rate hikes in the US.
China could look to partially offset US tariffs by allowing its currency to depreciate more quickly. Chinese currency depreciation has been a source of market volatility in the past, but unless a full-scale trade war breaks out, currency-driven volatility would likely be temporary. In a full trade war scenario, where the US imposes large, permanent tariffs on China and Mexico and those countries reciprocate, the negative effect on growth and investor sentiment could be a catalyst for a larger inflection point in markets.
Tariffs Could Affect Key Business Sectors
Source: Data as of 2014. Department of Commerce, Goldman Sachs Global Investment Research.
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