Right Now: The economy is in better shape than what many incoming presidents face. GDP is growing, unemployment is 4.9% and inflation is about 1%. Interest rates are already rising with the 10 year treasury topping 2% yield and the Fed is signaling a December increase in the Fed funds rate. U.S. stocks are enjoying a turnaround in earnings and are responding positively.
What Next? The Press is comparing Donald Trump to Ronald Reagan. Both are Republicans from outside the party establishment, both plan big tax cuts and changes in economic policy. Both are hailed as being in touch with voters. Reagan’s economic policy was tight money and increased federal spending. Combined with Paul Volcker’s inflation fighting at the Fed the economy emerged from a deep recession and grew. Stocks rose, interest rates fell as the bond market began a 30 year bull market.
Donald Trump’s approach to policy may be similar – he has said the Fed should raise rates and end its easy money approach; he wants to cut taxes and he speaks about a massive infrastructure spending program and increased defense spending.
However, the economy today is not the economy of 1980. Inflation is about one percent today versus 13% on Election Day in 1980; yield on the ten year T-note is 2% now versus 12% in 1980; GDP was up 2.9% in the third quarter and the last recession ended seven years ago. In 1980 we were in a brief pause between two recessions and the one that lay ahead was second only to the Great Recession in severity. There is at least one similarity: in 1980 and in 2016 there is a budget deficit which many people feared. Ronald Reagan promised to cut taxes, raise defense spending and balance the budget. He accomplished the first two – batting .667 may be a good score for a politician.
If Donald Trump follows a somewhat similar program, what might we expect?
- Interest rates are likely to rise – both the Fed and the President seem to be looking in that direction. But the rate increase is likely to be limited and the ten year Treasury note, now about 2%, will probably be 4% or less 18 months from now.
- Inflation should stay low. It has barely moved in a few years, expectations of future inflation, usually based on recent experience, are a key determinant of future inflation.
- Tax cuts are likely – Republican Congresses rarely raise taxes, although taxes did rise during the Reagan years.
- The stock market advance has further to go; it is supported by earnings, not politics, for the next six months.
- We will see a large infrastructure program. Almost as attractive to Congress as cutting taxes.
- The federal deficit will rise. Ronald Reagan preached supply side economics and the idea that cutting taxes would create so much growth that the budget would be balanced. It didn’t work then.