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Trump’s free lunch risks ending badly for markets

So Brexit was not a historical accident after all. The Trump victory seals it. A complacent, mainly urban liberal class, has been undone by a revolt. Nationalists are in charge of Washington and London now. These “strongmen” and “strongwomen” will control borders, restrict the movement of labour and subject cross-border M&A to ever tighter public scrutiny tests. Security will come first. The twin freedoms of capital and labour movement are fading, secular relics from a passing liberal age.

For those of us who have been investing professionally for the last 30 years, this new creed feels alien. That, of course, is part of the message, and we have no choice but to adapt to it. The rules of the game are changing, and we have to change with it.

The tendency of “strongmen” to use the state apparatus to conjure up growth will set our new course. The tedium of recent years, slow but steady growth, looks set to be dislodged by the seductive alchemy of a fiscally-induced boom-bust cycle beloved by populists.

Supply-siders will happily urge us to believe it will be all self-funding, while an explosion in fiscal indebtedness looks the most immediate outcome of Trump economics. Spending on infrastructure, defence, with cuts in corporate and personal income tax, without any corresponding cuts in entitlements, will make everyone feel good for a while, apart from bond investors. Trump has rarely had much time for them anyway.

So a US economic boom is almost certainly on its way. Tight labour markets can become tighter. Household incomes can hopefully start to grow again after years of stagnation. Markets can fret about wage inflation, but general price increases will be slower to respond. There is ample spare capacity in markets for traded goods and services in the US and elsewhere. Temporary dollar strength, salted with data-inspired Fed rate increases, will further temper the inflationary push.

Trump’s promise of a free lunch will devour the savings glut that has suppressed real interest rates over the last two decades. Lunch can last longer than many will think. The repatriation of offshore US corporate balance sheets will help finance the good times. The recycling of corporate balance sheets towards households is well overdue. “Trump’s triumph” heralds the early verdict. Real interest rates will need to adjust to a new equilibrium, a sign of success. Equities, especially US equities, rally. Wall Street bankers do quite well under Trump’s anti-establishment banner.

Meanwhile, the slow decay of the US fiscal position will take its time. It can await the company of an old friend: the trade deficit. The twin-deficit problem that troubled fiscal conservatives so in the 1980s can make its comeback.

Dr Henry Kaufman is poised for an Oscar-nominated return. Dr Doom, as he is fondly known, will remind us what this all ultimately means for interest rates and the dollar. The monthly trade data which once dominated the newswires, since usurped by the monthly employment report, can once again unnerve the dollar bulls. Populism and strong currencies are rarely seen together for long.

The trade deficit will be blamed on others of course: currency manipulators, global outsourcing, the carry trade. Mexico, the first casualty of the new world order, is already feeling this pinch: its net exports to the US an irredeemable liability in a world unhinged from formal multilateral duties. The recent falls in its currency and stock market are ready reminders of what America First means, soon to be followed by “China First”, “Japan First”, “France First” and so on.

And so the immediate outlook for risk assets is favourable. The market action of recent days is a reasonable assessment of what lies ahead. Fiscal policy will be highly stimulative, drawing down on the global savings glut, pushing up growth and real interest rates everywhere. It will feel good for a while, and then the financial strains will emerge, and then Dr Doom can make his untimely entrance.

Dominic Rossi is global chief investment officer of equities at Fidelity International

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