Mohamed A. El-Erian
Donald Trump's victory in the United States' presidential election surprised most of the world. But the president-elect is not finished defying expectations. Contrary to the predictions of many experts, stock markets have rallied strongly since his victory, with the three major US indices reaching record highs while the dollar has soared. Explaining these unexpected responses could provide a glimpse of what the next few months have in store for markets.
Before the election, most analysts predicted that a Trump win would trigger a large stock-market selloff and a rush into low-risk government bonds. And, indeed, when the results began rolling in, that is what happened, beginning with Trump's dramatic victory in Florida and gaining traction as his lead in the Electoral College grew. By the time that lead appeared insurmountable, the Dow Jones index of US stocks had fallen by 800 points, and the broader S&P 500 was "limit down." Moreover, the dollar began to slide, and a flight to quality in US Treasury markets caused bond yields to plummet.
But market pessimism did not last long. Soon after the president-elect delivered his acceptance speech in New York, at nearly 3 a.m. Eastern Standard Time, stocks began to rally - and have ever since, helping to boost risk assets around the world. With capital pouring into the US, the dollar strengthened to levels not seen for some 13 years.
In addition, many investors have abandoned the safety of government bonds, triggering a spike in interest rates even more pronounced than during the 2013 "taper tantrum" that followed former US Federal Reserve Chair Ben Bernanke's statement that the Fed intended to wind down its liquidity support. Markets are now all but certain that the Fed will pursue an interest-rate hike next month.
The most likely explanation for the turnaround lies in Trump's post-election remarks, which have focused largely on his economic agenda's pro-growth features, such as deregulation, corporate-tax reform, and infrastructure spending. Since the election, Trump has mostly avoided talking about his trade-protectionist campaign pledges, such as imposing punishing tariffs on China and Mexico, dismantling the North American Free Trade Agreement (NAFTA), and rescinding America's bilateral trade agreement with South Korea. Though he has reiterated his pledge to withdraw from the Trans-Pacific Partnership (TPP), that deal had not yet been ratified, anyway. And he has also chosen not to repeat his criticisms of the Fed and its leadership.
This shift in focus has convinced markets that Trump may well decide not to follow through on the more growth-damaging measures he suggested during his campaign. Trump has become far more conciliatory as well, telling the New York Times that he did not want to "hurt the Clintons" by appointing a special prosecutor to investigate his former opponent. Similarly, after years of criticizing President Barack Obama, Trump has spoken positively - even glowingly - about him.
Similar tendencies can be seen in Trump's approaches to his Republican campaign opponents, including House Speaker Paul Ryan and one of Trump's most outspoken Republican detractors, former Massachusetts Governor Mitt Romney. Given that Republicans won a majority in both houses of Congress and gained further ground at the state level, Trump's détente with the party establishment bodes well for the enactment of his pro-growth policies.
Of course, to make faster and more inclusive growth a reality, thereby validating exuberant markets, more will be needed - namely, careful design, broad political buy-in, and sustained implementation. Moreover, the team that will oversee that process has yet to be selected; like other appointees, its members could well face long vetting processes and, in some cases, confirmation challenges in the Senate.
Once the team is in place, its members will need to figure out how to make Trump's plans work for an economy that has - by necessity, not choice - been excessively reliant on unconventional monetary policies. The plan must recognize that, during this protracted period of monetary expansion, both financial markets and resource-allocation have been distorted, worsening wealth inequality.
The good news is that the incoming administration can draw on measures that were formulated during Obama's tenure, but which gained little traction because of the highly polarized and dysfunctional congressional politics that characterized most of Obama's eight years in office. Such measures address imperatives such as infrastructure investment, tax reform, and job creation.
But, of course, the US does not exist in a vacuum. External challenges must also be overcome - or, at least, contained - if the president-elect is to fulfill markets' expectations. Developments in Europe, which faces a series of potentially destabilizing political events in the next few months, will be particularly consequential.
Italy is about to hold a constitutional referendum that could result in the fall of Prime Minister Matteo Renzi's government. The United Kingdom has to produce a plan to guide a credible and orderly Brexit process. In France, the far-right National Front's Marine Le Pen will attempt to turn the upcoming presidential election into another anti-establishment upset. And, in Germany, Chancellor Angela Merkel will try to position herself to win another term next fall, in an environment that has been tripping up traditional politicians.
Notwithstanding the risk of instability in Europe, Trump is in a position not just to help boost growth in the US, but also to make it more inclusive. By pursuing a Congress-supported pivot toward a more comprehensive economic-policy stance, his administration's policy surge could also spur the private sector to begin using its large amounts of cash not for short-term financial engineering, but for growth-enhancing investments in plant, equipment, and people. If the economic frustration that drove so many Americans to vote for Trump is to be dissipated during his presidency, and if the market gains are to be validated and augmented, this prospect must become a reality.
Mohamed A. El-Erian, Chief Economic Adviser at Allianz, is Chairman of US President Barack Obama's Global Development Council and author of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse. Project Syndicate, 2016.