On Tuesday evening, Donald Trump will head to Capitol Hill to deliver an address to both houses of Congress. Such speeches have provided the US president’s predecessors with the opportunity to convey three main messages: their assessment of the country’s overall situation, the domestic legislative programme they hope Congress will pass in coming months and the main areas of global focus — all this in the context of the administration’s overall strategic vision.
Given the range of reactions to Mr Trump’s first month in office, this speech is one that will be closely watched and analysed, in the US and abroad. It will also be of interest to stock markets that, since Mr Trump’s election, have had a record-breaking run decoupled from the fluidity dominating the political landscape.
Markets are likely to continue to feel comfortable qualifying Mr Trump’s views on past economic developments. However, as policy details matter a great deal, they will pay close attention to any clarifications he provides on his legislative agenda, as well as on how he will handle negotiations with America’s trading partners.
Indeed, notwithstanding what have been limited details up to now, markets have already reflected certain expectations in a range of asset prices.
Given that Mr Trump said in his last press conference that his administration had “inherited a mess”, most market participants anticipate a rather downbeat assessment of economic conditions.
1. Dollar climbs on hawkish Jackson Hole speech from Fed chair Janet Yellen
2. Trump wins election and promises to unite the US, sparking dollar rally
3. Robust data push dollar up to 13-year high
4. Federal Reserve raises interest rates
5. Trump’s combative pre-inauguration press conference sparks investor uncertainty
But that is not what they have priced in. Instead, encouraged by better than expected data releases in Europe and the US, they are factoring in rising global growth and inflation, with the US contributing more as its own growth rate rises above 2 per cent and inflation settles at about the Federal Reserve’s target of 2 per cent.
This is not to say that markets have declared the “all clear” on the economy. Like the president, there are concerns about sluggish wage growth, a stubbornly low labour participation rate, excessive inequality and low productivity as well as uncertainty about what robotisation and other technological changes imply for the future of work and remuneration distribution.
But they also see a positive in so far as this constrains the Fed from raising interest rates too fast and too far.
The persistence of structural headwinds that hold back growth is one of the reasons markets will be looking on Tuesday for information on the implementation of the three main pro-growth themes of the Trump administration: tax reform, deregulation and infrastructure.
The content and timing of specific policy measures will influence the overall level of markets, as well as the composition of gainers and losers among sectors and companies.
Then there is the delicate issue of America’s economic interactions with the rest of the world. Until now, markets have been comfortable with the notion that, despite occasional protectionist rhetoric, the Trump administration’s guiding principle is fairer, but still-free, trade. And they believe that this can be achieved without disturbing value chains, dismantling the North American Free Trade Agreement, or cancelling bilateral free-trade agreements and imposing tariffs on China and Mexico.
Markets will be looking for reassurances that their take on trade policy is indeed correct. They will also hope that the administration’s evolving approach to currency policy — one that has already departed from the practices of previous administrations, partly by softening the strong dollar mantra — is aimed at encouraging other countries to do more on policies that enhance growth there and strengthen their own currencies. This would thereby limit the risk of a destabilising excessive appreciation in the dollar.
As markets are in the business of pricing the future, these expectations have already been reflected in valuations. Stocks and corporate bonds have rushed to price hopes of stronger economic growth and corporate earnings, driven in large part by widening policy improvements after too many years of politically induced paralysis.
Should such expectations not be validated by Tuesday’s speech and what follows in terms of legislative actions, markets could well have quite a rude awakening.
Mohamed El-Erian is chief economic adviser to Allianz and author of “The Only Game in Town’”