More of the same: Why politics matters more than ever in 2017
Steven Malin, Senior Investment Strategist, US
Welcome to Trump’s America
2016 was a year where politics was the master of financial markets, and one of the key discussions at the Investment Forum was the likely political risks facing investors in 2017. The political discussions began with a view from the US, as Senior Investment Strategist Steven Malin explored some of the possible developments in the US under President Trump.
There remains significant uncertainty around what policies President Trump will choose to focus on, but Steven argues that Trump’s “Contract with the American Voter” indicates where his priorities lie. He said that Trump will take action to ‘protect American workers’, including renegotiating NAFTA, withdrawing from the Trans-Pacific Partnership, and redirecting funding away from climate change programs to US infrastructure spending. Additionally, he said that Trump has promised an overhaul of the tax code, which could include a 35% tax cut for the average American family.
The Federal Reserve
One of the biggest issues facing investors will be what occurs at the Fed (US Federal Reserve). Steven argued that one of the first items on Trump’s economic agenda will be to fill a number of vacancies on the Federal Reserve’s Board of Governors.
The Board of Governors is the main governing body of the Federal Reserve, and is responsible for overseeing the regional Federal Reserve Banks, and implementing US monetary policy. The seven-person committee is currently chaired by Janet Yellen, and makes up seven of the twelve members of the Federal Open Market Committee, which decides US interest rates and money supply.)
By the middle of 2018, six out of the seven positions could need filling, and Steven reasoned that Trump will likely choose appointees who share his views on the world. This could have far-reaching impacts on interest rates, the central banking system, and banking regulation. Given that the dollar is the world’s reserve currency, and that US Treasury yields have a significant impact on global capitals flows, the approach the Fed takes and its level of independence need to be scrutinised by investors.
By mid-2018, the Board of the Federal Reserve could have six out of seven seats vacant
Another key pillar of Trump’s platform is reforming the US tax system. Steven claimed that Trump’s proposed tax changes could represent the single biggest change to the US taxation system in a hundred years. For individuals, Steven showed how Trump would simplify existing tax bands, and reduce average federal taxes for all earners.
For businesses, the corporate tax rate will be reduced from 35 percent to 15 percent, and he would give firms a one-off opportunity to repatriate corporate profits held offshore at a tax rate of 10 percent. However, Steven cautioned that all these changes would need to be passed by Congress, and Republican deficit hawks in the House and Senate may block or water down such proposals.
Figure 1: Federal taxes under Trump's plan
Ingo Mainert, CIO Multi Asset Europe
Europe after Brexit
Donald Trump might be stealing the limelight, but Europe is not short of potential political issues either. Brexit has naturally dominated the political agenda in 2016, and will continue to be the big story in 2017. However, beyond this Ingo Mainert, CIO Multi Asset Europe, believes that the upcoming ‘super election’ cycle in Europe could create some potential flashpoints for investors.
Over the course of 2017 three ‘core’ European countries are holding elections. Ingo argued that we could see an upset in the Netherlands, where the nationalist Gert Wilders is polling better than many expected. In France, much has been made of the rise of Front National, but Ingo contended that the election could be a positive surprise, with moderate Francois Fillon performing well in the polls. Finally, we also have elections in Germany in September, where Angela Merkel will have to fight off the insurgent right wing AfD party. Ingo also warned that we could see another election in Italy, and a referendum in Spain on the future secession of Catalonia.
However, despite the potential for some positive surprises in Europe, Ingo viewed the Italian economy as potentially the most difficult issue for the Eurozone over the short term. The country continues to suffer from unsolved problems, mainly in the banking sector.
Figure 2: High NPLs put strain on the banking sector
Unfortunately, the government is paralysed and weak, and Ingo discussed the possibility that some of the recent constructive reforms such as changes to labour laws could be revised. Italian governments are notoriously unstable, with a quite extraordinary average government tenure of just 1.1 years since the end of World War II. After the failure of Matteo Renzi to win the referendum on constitutional reform Italy is at a clear crossroads, and investors need to pay close attention to potential flashpoints here.
25 years after the Maastricht Treaty the European project is now at a key juncture, and Ingo argued there are four different potential outcomes.
The chance of an ‘ever closer union’ with greater European integration seems to have declined further than ever before, with individualist nationalist agendas on the rise across Europe.
A possible scenario that Ingo imagined could emerge is a ‘two-speed’ Europe, with ‘Core Europe’ moving towards greater integration, as fringe members break away.
The political landscape ahead is certainly a rocky one, with considerable uncertainty across the world. Investors need firstly to be aware of political developments and their impact on markets, and secondly to remain diversified to cope with any shocks.
The rise of Trump and Brexit have very clearly signposted the beginning of a different era of politics that investors need to take heed of, and 2017 could be a year of significant change in Europe.