A Trump White House: Potential market impacts

Donald Trump's presidential upset has stunned financial markets. What might Trump's policy proposals mean for markets and key components of the U.S. economy going forward? The questions outnumber the answers at this stage, but here are our best guesses.

Gross domestic product: Overall GDP growth should be faster, thanks to tax cuts and infrastructure spending. Trump's policy proposals call for an aggressive easing of fiscal policy, and we are left with questions on the distribution of tax cuts (will they favor high-income earners with low marginal propensity to consume?) and how they will be funded (upfront spending cuts or delayed cuts?).

We believe the major risk of the Trump administration is a supply-side hit to the economy stemming from a potential trade war with higher tariffs and reduced supply of labor due to tougher immigration enforcement. Recession odds increase in the medium term if an initial GDP growth spurt is met with higher interest rates and followed by a negative supply-side shock driving inflation much higher.

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Research indicates there has been a drop in worker productivity and other consequences following the election of Donald Trump. Therapists refer to this as Trump Anxiety Disorder.

Inflation: Trump's proposals are structurally inflationary, but which measures will get passed and implemented is a large unknown. He's calling for aggressive fiscal policy; an exit of many immigrants (which would put upward pressure on domestic wages and costs) and increased protectionism (a trade war would likely depress growth initially and ultimately raise the cost of global goods via higher tariffs). The supply side of the economy could take a serious hit.

Tax policy: Trump initially talked about $9 trillion worth of cuts over 10 years. He later reduced his proposal to $4 trillion; Congress might pass something more reasonable, like $1 trillion. The unknowns on the tax cuts are how they will be funded, their distribution and impact on GDP. On plan, the cuts favor the top income earners who may be less likely to spend. Trump would like to achieve comprehensive tax reform:

• Broaden the base.
• Remove loopholes.
• Reduce tax rates.
• Collapse individual tax brackets from seven to three (12 percent to 25 percent to 33 percent).
• Reduce the corporate tax rate from 35 percent to 15 percent.
• Remove the estate tax.

So far, he seems to assume revenue loss would be offset by faster GDP growth.

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Federal Reserve: Trump has already suggested that Federal Reserve Board chair, Janet Yellen, would not likely be reappointed when her term ends in February 2018. We could see preference for a more hawkish Fed chair, someone like former Dallas Federal Reserve president Richard Fisher, with a more orthodox view on monetary policy. The fed funds rate should rise faster under Trump.

Interest rates: Longer term, our bias is that the Fed funds rate and bond yields will rise as aggressive fiscal policy easing spurs demand. Loose fiscal measures could then meet potential trade and immigration restrictions, leading to higher inflation. From here, spread levels could stay flat or move wider. Increased volatility and uncertainty are anticipated in the near term, and the non-financial corporate sector has continued to add leverage.

Credit spreads: The Trump victory suggests bolder policies and wider tail risks for the corporate sector. We need to see profits rise relative to debt for credit spreads to remain at current levels. If spreads were to tighten from here, it would probably be on the back of higher Treasury yields compressing the credit spread.

Equity: Near-term uncertainty could be negative for equities. The long-term picture is cloudy, but it hinges heavily on the economy and how fast Trump's prospective tax cuts might speed growth. We'll watch for tension between a fiscal-driven boost to GDP, higher interest rates and potential for a trade war. In any case, stronger profits and greater investment spending are critical for both economic and profit growth.

U.S. dollar: We have a more bullish outlook for the dollar under a Trump presidency. A key assumption is that loose fiscal policy and tight monetary policy are typically bullish for a currency. Think of the 1980s, when President Reagan's tax cuts, a defense buildup and Volker-led Fed combined to drive the dollar to very high levels.

Trade: Trump campaigned on a protectionist, isolationist platform, and tariffs on China and Mexico could become reality. A trade war is the biggest risk to global GDP, and the fallout would likely be a negative hit to supply, raise inflation and slow global demand.

— By Tom Fahey, associate director of macro strategies at Loomis, Sayles & Co.