USA – Page 34 – Digital Finance Analytics (DFA) Blog

President Trump signals a return to the Wild West days of finance

A stream of commentary has set out to explain the electoral success of Donald Trump as a reaction to globalisation and neoliberalism. It points to a thread of populist anti-capitalism running from the President-elect to Bernie Sanders.

To the extent that this is true, however, Trump voters may be in for a surprise. One of the headline reforms of the incoming administration will be the undoing of regulatory responses to the 2008 financial crisis. This is not just inconsistent with pre-election rhetoric, but highly significant for financial markets.

Releasing financial actors from the shackles of regulation may sound appealing for business, but will also increase the risk of another financial crisis. Trump policies are likely to create a more dynamic, but crucially more risk-prone financial system, not only in the US, but globally.

In particular, he has spoken of dismantling the Dodd-Frank Act, which introduced extensive regulation of the financial industry in the wake of the global financial crisis. This is pleasing the markets, but may lead to the same kind of risk-taking that precipitated the 2008 crisis.

Ending state intervention

The President-elect’s newly-established transition website declares: “The Dodd-Frank economy does not work for working people.” Bureaucratic red tape and Washington mandates, according to Trump, have hindered America’s economic recovery. The new administration promises to dismantle Dodd-Frank and replace it with new policies to encourage economic growth and job creation.

Yet, it was exactly this type of deregulation between the 1980s and the middle of the 2000s that was a principal cause of the crisis. This is why the Dodd-Frank Act included provisions that affected virtually every financial market and granted new authority to nearly every federal financial regulation agency in the US.

It was designed to prevent excessive risk-taking by companies and investors. It introduced greater regulation of Wall Street and increased the government’s power to intervene in the event of a repeat crisis.

It also created a consumer watchdog to oversee the sale and marketing of financial services to consumers, such as the mortgage companies and pay-day lenders that profited prior to the crisis. This was the idea of liberal Democratic Senator Elizabeth Warren and has been singled out as a source of wrath for Republicans as it is emblematic of state intervention in financial markets.
Tough on banks: Democratic Senator Elizabeth Warren. EPA/Michael Reynolds
On the chopping block

Scant detail of what Dodd-Frank will be replaced with is available at the moment. Some indication comes from Republican Party proposals to undermine post-crisis regulation, which culminated in a bill introduced by House Financial Services Committee Chairman Jeb Hensarling earlier this year.

The Hensarling plan would place heightened restrictions on financial regulators trying to write new rules, and give large financial institutions a way to ease their regulatory burden. Such institutions would be given the option to opt out of some government oversight if they agree to hold on to larger amounts of capital.

Huge portions of Dodd-Frank are up for elimination including the “orderly liquidation authority” through which regulators can shut down ailing banks. Perhaps more emblematically, the “Volcker Rule”, which bars banks from engaging in profit-seeking activity known as proprietary trading, would also be repealed. And Congress could also cripple the new consumer watchdog by taking control of both its budget and management. It may also lose the ability to ban financial products it deems to be “abusive”, and its ability to gather consumer financial data.

Expecting the unexpected

Isn’t an attack on government agencies and “bureaucracy” part and parcel of a Republican administration? Perhaps. But during the long electoral campaign many unexpected things happened in this new populist phase of American politics.

For example the Republicans joined forces with the left of the Democrats in asking for the restoration of the Glass-Steagall Act. This was one of the most important legislative responses to the failures that led to the Great Depression, particularly in the banking sector. The act’s backers were convinced that the banks had played a significant role in promoting unsustainable booms in the real estate and securities markets during the 1920s.
Market reaction to Trump’s election win. EPA/Justin Lane
Glass-Steagall prevented commercial banks from making unsound loans and investments that can lead to a housing market bubble. It also discouraged banks from making investments in securities that undermine their solvency during stock market downturns and stopped them from making loans to finance the purchase of securities.

It takes a few intellectual leaps to go from advocating the return of 1930s regulation to dismantling post-2008 crisis responses. Yet this is the direction that Trump’s team appears to have taken.

The markets, unsurprisingly, have reacted well. This should leave nobody wondering. With regulations up for the chop, banks reduce their compliance costs and can increase profit margins. The financial industry had a look at the first pronouncements of America’s new rulers, and liked what it saw.

Author: Ioannis Glinavos, Senior Lecturer in Law, University of Westminster

Federal Reserve Board orders JPMorgan Chase & Co. to pay $61.9 million civil money penalty

The US Federal Reserve Board on Thursday ordered JPMorgan Chase & Co. to pay a $61.9 million civil money penalty for unsafe and unsound practices related to the firm’s practice of hiring individuals referred by foreign officials and other clients in order to obtain improper business advantages for the firm.

In levying the fine on JPMorgan Chase, the Federal Reserve Board found that the firm’s Asia-Pacific investment bank operated an improper referral hiring program. The firm offered internships, trainings, and other employment opportunities to candidates who were referred by foreign government officials and existing or prospective commercial clients to obtain improper business advantages.

The Federal Reserve found that the firm did not have adequate enterprise-wide controls to ensure that referred candidates were appropriately vetted and hired in accordance with applicable anti-bribery laws and firm policies.

The Federal Reserve’s order requires JP Morgan Chase to enhance the effectiveness of senior management oversight and controls relating to the firm’s referral hiring practices and anti-bribery policies. The Federal Reserve is also requiring the firm to cooperate in its investigation of the individuals involved in the conduct underlying these enforcement actions and is prohibiting the organizations from re-employing or otherwise engaging individuals who were involved in unsafe and unsound conduct.

The Federal Reserve is imposing the fine and requiring the firm to modify its practices concurrently with actions by the U.S. Department of Justice and the Securities and Exchange Commission.

Trump and Reaganomics

The Economist has highlighted that whilst much is yet to be revealed, the Trump administration-in-waiting seem to imply an expectation of a Ronald Reaganesque turn in American fiscal policy. Yet, they say, any resemblance that Mr Trump’s plans may bear to Reaganomics is as much a cause for concern as for optimism. They call out three areas of risk.

The first is financial instability. The Federal Reserve has prepared markets for a gradual pace of monetary tightening. Should higher inflation convince the Fed that more interest-rate hikes are needed sooner, many investors in emerging markets could be caught off guard. A bout of chaotic capital flight could threaten shakier banks or induce governments to adopt capital controls. America, which eventually intervened to help manage the Latin American debt crisis, will probably be slower to lend a hand under Mr Trump.

Second, faster growth and higher interest rates might attract foreign capital and place upward pressure on the dollar, which has indeed been rising since the election. That will help exporters to America and hamper a manufacturing revival in the struggling towns that helped Mr Trump win. In fact, the Mexican peso has fallen by about 10% against the dollar since the election, boosting the competitiveness of Mexican firms relative to their American counterparts. Yet Mr Trump will find responding to these shifts to be trickier than did Reagan. Sprawling supply-chains mean that punitive tariffs are less obviously useful to domestic firms than they once were. A battle over exchange rates between America and China could prove far more dangerous, both economically and geopolitically, than Mr Baker’s negotiations.

Third, further cuts may deliver a smaller boost to growth as a result. Inequality is far higher now than it was in the early 1980s; slashing tax rates on the rich while unravelling recent financial regulation could push economic divisions to unprecedented, politically toxic levels.

The global economy could use more fiscal stimulus. A raft of regressive tax cuts from a protectionist-minded American administration is, to put it mildly, a risky way to provide it.

Trump hasn’t derailed Chinese homebuyers’ obsession

From South China Morning Post.

Donald Trump’s presidency won’t hurt the rising tide of Chinese investment into the United States – in fact, the level of cash may actually increase, according to Knight Frank.
new-york-8

Trump’s shock election last week rattled markets around the world and analysts continue to disagree on what the Republican candidate’s victory means or how it will affect the US property market, the No 1 destination for Chinese capital. “The short answer is I am not worried about Trump’s impact on Chinese flows into America,” Knight Frank’s global capital markets head Peter MacColl told the Post during a visit to Hong Kong last week.

“Whilst he’s come out with a lot of rhetoric, what might be considered to be barmy ideas that might have an impact on the geopolitical scene globally, the American system of checks and balances through Congress, through all the advisory parties that any change has to go through, means any really radical things won’t happen overnight,” he said.

“I don’t think there will be a big downturn in the property market because of Trump, and if anything, there could be a bit of an upturn because of his policies towards business generation and self responsibility.”

In the short term, MacColl expects there to be a bit of “waiting in the wings and seeing what’s going to happen”.

“A bit of caution, a bit of a slowdown just in terms of making decisions – which is understandable – until maybe the new year when things start to pan out a bit.”

But MacColl said he didn’t see a lot of risk to mainland Chinese investors in the US from Trump’s presidency and expected the US to remain the favoured destination for Chinese capital.
There wasn’t just a pull factor, there was also a push factor, with Chinese investors keen to take their money out of the country as the yuan continued to be devalued, he said.

The total volume of Chinese outbound real estate investment between January and October is slightly down on the same period last year, according to Knight Frank research.

But not everyone was so positive. Jefferies equity analyst Mike Prew said the combination of a possible post-election Federal Reserve rate rise in December and rising bond yields compared with property yields could have an effect on the returns in the US’s $27 trillion residential market.

“Things could get messy for real estate,” he said.
He tipped Canadian residential markets of Toronto, Montreal and Vancouver to be the big property winners following the US election.

Simon Smith, head of research and consultancy for Savills, agreed that investors would stay cautious for the rest of this year and capital volumes might be more muted.

“The uncertainty continues to drive people to the United Kingdom,” he said, noting that Brexit had also worked out positively for the British property market thanks to the falling pound – something which hadn’t happened to the US dollar. “It looks like the UK remains a net beneficiary of what’s been happening.”

Trump’s indication that he would invest in infrastructure was judged as positive by investors, but question marks remain over the wider policy direction of his presidency.

“I don’t think the clouds have parted quite yet on Trump and what election promises he may or may not choose to enact. We’re still asking ourselves: is this soft Trump or hard Trump?”
New York real estate company CityRealty’s director of research Gabby Warshawer said it was difficult to predict the long-term implications of Trump’s presidency on New York property,
which was the top destination for Chinese capital investment in the first six months of this year.

“If the stock market were to be extremely unsettled for a long period of time, that would have a clear effect on real estate — for example, following the financial crisis in late 2008, it took more than three years for New York real estate prices and sales volume to bounce back,” she said in an emailed response to questions from the Post.

“That being said, analysts have not been predicting a protracted doomsday scenario for the markets following this election.”
She said it was unlikely there would be significant change in Chinese investment following the election as the buying spree had a lot to do with property market conditions in China.

“If there is significant turmoil and the United States is no longer considered as safe for real estate investments as it has been in recent years, then that would impact all international buyers,” Warshawer said.“The New York City real estate market is stable and exceptional enough that it is still generally seen as a safe long and medium-term investment by most buyers, regardless of campaign rhetoric.”

The Great Interest Rate Pivot

Following the news from the US last week, the yield on the benchmark 10-Year bond has risen. This may signal the end of ultra-low interest rates and low inflation, and may create new challenges for central banks.

This is because the US benchmark has impact on the global capital markets, and will push other rates higher. This may see stock markets fall. Inflation may rise.

So, in Australia, we are probably at the bottom of the rate cycle, and the next move will be up. But meantime, as banks continue to rely on the international capital markets for some of their funding, expect out of cycle rate rises. Some fixed rate mortgages have already risen. Most households are on a variable rate mortgage, so would feel a rise straight away.

However, it may be good news for savers because conceivably savings rates will also begin to improve.

The sleeper of course is the potential hit on international trade should the US start a trade war. The fallout of a trade tariff argument between USA and China could hit Australia hard. If it did, we have little left in rate cuts to stimulate further, so employment may fall.

But given household debt is high, and mortgage repayments already large, any rise in rates would reduce household spending and lift delinquencies higher. Both depressive on house prices.

The next few months will be “interesting”!

What’s behind the Trump bump in markets

From The Conversation.

The market bounced back after Trump’s victory in the US election, despite predictions that his policies could hurt business. This relates as much to the surprise return of a Republican Congress as it does to the election of Trump. It also largely turns on Trump being unable, or unwilling, to act on much of his rhetoric.

One research paper predicted a market fall of up to 10% if Trump won. The governor of the Reserve Bank of Australia indicated that Trump could trigger a shock greater than Brexit.

However, the US Dow Jones Industrial Average advanced 1.4% on Wednesday, and a further 1.17% on Thursday. Asia-Pacific markets also plummeted initially, as markets realized Trump would win, but recovered later – the Australian ASX 200 index fell 1.9% on Wednesday (Australian time) as Trump’s victory became apparent, but rose 3.3% on Thursday.

This is surprising given the US market generally declines around 1% following a presidential election. For example the market fell on the elections of Obama (5.27% in 2008; 2.37% in 2012), Bush (1.58% in 2000) and Reagan (0.73% in 1984).

The Trump rally is even more unusual because the market had already priced in the likelihood of a Clinton win, and a Clinton victory seemed likely.

The rally implies businesses believe that not only is Trump not harmful, he might be better than Clinton. A benign, conciliatory, and well-received victory speech alone could not achieve that: a passable speech does not erase myriad speeches with heated rhetoric.

Some sectors might benefit from Trump and a Republican Congress

Trump could benefit some sectors. These benefits arise from relaxing prior executive orders through to avoiding onerous regulation, which could otherwise potentially harm some sectors. Here’s a few examples.

Pharmaceutical companies: The Republican Party and Trump are unlikely to restrict drug price increases or to heavily scrutinize such increases. Trump’s health care policy platform is largely silent on drug prices. And due to large donations from the pharmaceutical industry, the Republican House Ways and Means Committee isn’t likely to back Medicare negotiating on drug prices.

By contrast, a simple Clinton tweet criticizing drug price increases before the election coincided with the Nasdaq Biotechnology Index declining by 4.7%.

Post election, pharmaceutical companies were prominent in the Trump Rally – Pfizer alone rose 7.07% on Wednesday and 4.27% on Thursday.

Resources companies: Long term, climate denial could hurt the economy through factors such as decreased agricultural production. Trump has little in the way of plans to combat climate change, with his policy platform also silent on this issue. But Trump and Pence have indicated they will “end the war on coal”, and this is part of the Republican policy platform as well.

Further, Trump has stated he will “rescind all the job-destroying Obama executive actions including the Climate Action Plan”. This highlights that on top of legislation that might be passed by Congress, Trump can himself repeal Obama’s executive orders limiting emissions.

In the short term, some resources industries will gain from these relaxed climate-related restrictions. These range general environment regulations through the reduced likelihood of serious pollution targets. Both Chevron and Exxon Mobile experienced moderate gains, increasing by 0.33% and 1.10%, respectively, on Wednesday.

Banks: Breaking up the banks was something touted by Trump during the campaign. However, a Republican congress with a Republican president is unlikely to increase banking regulation. In fact, there have already been attempts to significantly alter post-financial crisis banking regulations.

Despite the rhetoric, Goldman Sachs, rose 5.89% on Wednesday and 4.28% on Thursday, following the election. Morgan Stanley, J.P. Morgan and other banks experienced similar gains.

Growth prospects and infrastructure

On top of these issues affecting individual industries, markets are arguably factoring in some prospect of renewed growth under Trump. This in part comes from promises to reduce taxes and to boost infrastructure spending, which are in turn linked to a potential commodities rally. Indeed, Trump indicates he will spend heavily on infrastructure, which could involve upwards of US$500 billion in infrastructure spending.

The optimism from markets might also be based on the assumption that increased spending will increase employment in the short term, and increase overall economic activity in the long term. And that lower taxes will encourage corporate investment and growth, potentially luring back companies from low tax rivals.

Trump has a personal stake in not harming business and his powers are limited anyway

The last potential factor is that Trump has extensive business affairs, giving him a vested interested in avoiding economic damage. His policy platform actively affects his personal affairs through its impact on the economy and immigration. Assuming he acts in a rational, self-interested, manner, he will avoid damaging protectionist policies that might influence his businesses’ operations.

This assumption is bolstered by his transition website which promotes his brands, giving every indication that he will at least attempt to minimize harm to his companies.

Further, even if he attempts to promote harmful policies, the president has limited powers. He cannot create legislation and is largely limited to approving or vetoing legislation passed through Congress. A president can issue Executive Orders, but their scope is limited. Further, a rational Congress could mitigate, and need not act upon, Trump’s heated campaign rhetoric.

The market appears to have responded positively to Trump’s election in the short term. The hope is that he will generate economic growth, that his policies will moderate his rhetoric, and that he will be unable to unilaterally achieve aspects of his policy platform.

It remains to be seen whether this holds up in the long term. The share market remains relatively volatile, as evidenced by the rapid changes in Asia-Pacific markets. The positive sentiment could easily reverse if the market’s positive expectations do not materialize.

Author: Mark Humphery-Jenner, Associate Professor of Finance, UNSW Australia

Trump Regulatory Changes May Not Be a Win for Banks

Fitch Ratings says US financial institution (FI) regulatory reform may feature as a priority legislative agenda item, reflecting the campaign of President-elect Donald Trump as well as the ongoing views of several key majority Congressional leaders.

Fitch does not foresee any changes to US FI ratings as a result of the election. Changes that potentially reduce capital or liquidity requirements are likely to be a negative, but the impact on individual ratings will depend on how banks respond to this change. To the extent that capital or liquidity levels decline materially, that could result in negative rating implications, but Fitch views this scenario as unlikely.

The Dodd-Frank Act (DFA) has featured as a target in President-elect Donald Trump’s campaign statements, but most aspects of DFA have been implemented, and it is unclear whether a wholesale repeal could pass or what a partial repeal may encompass.

The Consumer Financial Protection Bureau is a relatively high-profile target for those opposed to the DFA, but its elimination on its own would be unlikely to have a material impact for banks in the aggregate. Notably, there has been little specific discussion of peeling back the Volcker Rule or Resolution Authority, some of the more costly aspects of the DFA. Fitch notes that the reduction in proprietary trading activity linked to Volcker has been largely positive for banks, while the resolution process has been largely positive for banks’ governance.

Anti-Wall Street sentiment has been a recurring theme in the presidential campaign for both candidates, so it remains an open question as to the likelihood or urgency of any proposed financial sector regulatory reform or repeal. Smaller regional or community banks may be viewed as more worthy beneficiaries of regulatory relief than money center banks. In addition, the reintroduction of Glass-Steagall (GS) is unlikely to be a policy priority. The reintroduction of some elements of GS was included in both parties’ platforms, but it was not a prominent theme in the campaign. The industry is likely to continue to strenuously oppose regulation that would re-impose restrictions that had existed under GS.

It is also important to note that capital and liquidity requirements have not historically been dictated by the Legislature but through banking regulators in the US. The US has adopted Basel III and those requirements will continue to be implemented, regardless of the administration. Therefore, while aspects of the DFA may be peeled back, core banking regulation is unlikely to change.

Generally, US financial institutions’ performance tends to be correlated with the overall US macroeconomic environment, particularly as it relates to economic growth. Judging by the campaign, the new administration’s economic policy is likely to revolve around tax cuts, renegotiating trade agreements, de-regulation and higher infrastructure spending. However, it remains to be seen the degree to which Trump will implement or be able to carry out his policy initiatives and the long-term effect policy changes will have on growth.

In the near term, increased policy uncertainty could dampen prospects for private investment growth. If the Fed judged these effects were likely to outweigh the impact of any additional fiscal easing, it may prompt them to raise rates at a slower pace than previously expected over the coming year. This would delay any positive operating leverage from rate hikes out further, as the impact tends to be lagged. Overall, Fitch expects that incremental interest rate increases would be positive for banks’ net interest margins.

Aging Boomers May Stymie Trumponomics

Moody’s says not only did the wide majority of experts incorrectly predict the outcome of the US Presidential election, pundits also were far off the mark regarding how markets might react to an improbable Donald J. Trump victory. Instead of conforming to pre-election expectations of an equity market sell-off and lower interest rates, both share prices and bond yields have soared since Trump’s victory. Whether they remain higher depends on a widely anticipated acceleration by business sales vis-a-vis employment costs that may not materialize.

As inferred from recent market performance, the economic, taxation, and regulatory policies of the past eight years curbed business activity considerably and, by doing so, reined in the growth of attractive job opportunities. To the degree existing policies limited US business activity, they very much facilitated Donald Trump’s Presidential upset. Perhaps, “secular stagnation” is partly the offshoot of suboptimal government policies that helped to slash US real GDP’s average annual growth rate from the 3.3% of the 10-years-ended 2006 to the 1.3% of the 10-years-ended 2016.

Nevertheless, unprecedented demographic change that is beyond the scope of an immediate government remedy is one of the major drivers of “secular stagnation”. The aging of the US population complements the deceleration of growth quite nicely.

When the US economy grew by 3.3% annually during the 10-years-ended 2006, the number of Americans aged 65 years and older rose by 310,000 annually, on average, while the number aged 16 to 64 years — a proxy for the working-age population — expanded by a much greater 2.36-million annually. By the 10-years-ended 2016, the average annual increase in the number aged at least 65 years soared to 1.28 million as the annual addition to the working-age population sagged to the same 1.28 million.

Notwithstanding the likely implementation of more stimulatory policies, US growth during the next 10-years-ended 2026 will still be constrained by projected average annual increase of only 470,000 for the number of 16- to 64-year old Americans, which is far less than the forecasted average annual addition of 2.05 million to the ranks of those 65-years and older.

If, as expected, the US working-age population grows by 0.5% annually during the next 10-years, then a likely range of 1.0% to 1.5% for the average annual rate of labor productivity growth suggests that US real GDP will increase by between 1.5% and 2% annually through 2026, which is much slower than its 3.2% average annualized increase of the 25 years ended 2006.

Older workforce may keep 10-year Treasury yield under 3% to 5% range. In addition to the overall population, the US workforce is also getting older in a manner never seen before. Since June 2009’s end to the Great Recession, the cumulative 8.5% growth of household-survey employment was unevenly split between a 3.9% increase in the number of employees aged less than 55 years and a 28.0% surge for the employment of Americans aged at least 55 years.

If employment growth remains skewed toward older workers, part-time workers will probably constitute an above-trend share of employment, while the growth of both personal income and household spending will be slower than otherwise. The underlying growth of both income and spending slowed as the share of workers aged at least 55 years soared from October 1996’s 12.1% to October 2016’s 22.8% of total US employment.

Some now warn of an impending climb by the 10-year Treasury yield to a range of 3% to 5%. However, an older workforce weighs against a much higher benchmark Treasury yield. An older workforce and an aging population are expected to limit the upsides for inflation risk, private-sector borrowing, and household expenditures growth by enough to prevent the 10-year Treasury yield from becoming stuck in a range of 3% to 5%.

Credit Markets Review and Outlook

As illustrated by Figure 1, the 10-year Treasury yield maintains a strong correlation of -0.84 with the share of employment aged at least 55 years. Getting to a forecast midpoint of 3% for the 10-year Treasury requires that the employment of Americans aged at least 55 years drop from October 2016’s 22.8% to roughly 20% of total employment. Such a rejuvenation of US employment is highly unlikely. The impossibility of making America young again renders it all the more difficult to make America great again. (Figure 1.)

Equity rally helps to drive benchmark yields sharply higher

Thus far, earnings-sensitive markets view the Republican sweep of the House, Senate, and Presidency positively. Since November 8’s election, the market value of US common stock was recently up 1.9%. Moreover, after the VIX index’s average soared from October 2016’s 14.6 points to the 20.0 points of November’s first eight days, this equity market “fear factor” subsequently dropped to a recent 14.6. The latter has been statistically associated with a 430 bp midpoint for the high-yield bond spread, which was thinner than November 9’s band of 508 bp.

The post-election equity rally stems from improved prospects for business activity and profits. The Republican sweep boosts the odds favoring a fiscal stimulus package that includes lower tax rates on personal and corporate income, as well as stepped-up infrastructure spending. Moreover, a much reduced rate of taxation on the repatriation of corporate cash held overseas is probable.

In addition, business operating costs are likely to be effectively reduced by the repeal of the Affordable Care Act and a broad-based easing of federal regulations. On the regulatory front, Bloomberg reports that Trump’s Financial Services Policy Implementation team will devise a strategy that aims to dismantle 2010’s Dodd-Frank Act. Expectations of both Dodd-Frank’s demise and Fed rate hikes have driven the KBW index of bank stock prices up by more than 9% since November 8.

Nevertheless, upwardly revised outlooks for business activity and corporate earnings quickly drove the 10-year Treasury yield up by 27 bp from November 8’s close to a recent 2.13%. Not since January 2016 has the 10-year Treasury yield been this high.

Recent auctions of new 10- and 30-year Treasury bonds were weak. The 2.22:1 bid-to-cover ratio for November 9’s $23 billion auction of 10-year Treasury notes was the lowest since March 2009. In addition, foreign participation was weak at both sales. Trump’s surprising victory may have temporarily scared off foreign buyers of US Treasuries.

Nevertheless, the dollar exchange rate has climbed higher since the election. The recent widening of the yield spreads between US Treasuries and the sovereign government bonds of other advanced economies may help to further firm the dollar exchange rate, where expectations of an even stronger dollar may contain Treasury yields by (i) reducing inflation expectations, (ii) boosting foreign purchases of US Treasuries, and (iii) lowering the outlook for US corporate earnings.

Credit Markets Review and Outlook

Despite a costlier dollar exchange rate, industrial metals prices have soared. On November 9, Moody’s industrial metals price index was up by 29.4% from a year earlier.

However, the still relatively modest pace of global industrial activity questions the sustainability of the latest surge by base metals prices. Perhaps, speculative buying in anticipation of a lively rejuvenation of global industrial activity now drives base metals prices higher. If the world’s consumers fail to cooperate and spending does not rise by enough to support costlier base metals, base metals price deflation will return.
Given the persistent price deflation afflicting tangible consumer goods, manufacturers will have difficulty passing on higher materials costs to final product prices. In October, the annual rates of price deflation were -2.3% for the consumer durable goods’ component of the PCE price index and -0.6% for the core consumer goods price index. The underutilization of the world’s production capabilities should continue to contain prices of internationally tradable products regardless of forthcoming stimulus and deregulation.

A fundamentally excessive climb by Treasury bond yields could sink share prices and widen spreads. Thus, credit-sensitive activity may offer insight as to how high interest rates might climb. In view of how unit home sales recently slowed amid a less than 3.5% mortgage yield, an impending climb by the mortgage yield to a range of 3.75% to 4% risks an outright year-over-year contraction by home sales.

Trade with China or security with the US? Australia will have to choose

From The Conversation.

Donald Trump’s victory promises a further departure from the traditional Asia-Pacific order created during the Cold War years. This was when the US provided military and economic dominance through a system of defence alliances with the major trading partners in the region, including Australia.

The old Asia-Pacific order was based on the exchange of security for free trade. With the demise of the Soviet Union and the rise of China’s market economy, the Asia-Pacific order is now in an evolutionary phase.

Now the hierarchy of countries is splitting between security – still dominated by the US, and the economic order- which is being overtaken by China.

In the middle of this competition between the US and China, there are the Asia-Pacific countries dealing with China for economic gains without giving away American security patronage. Japan and Australia best exemplify these countries.

For example, both are negotiating the Trans Pacific Partnership and the Regional Comprehensive Economic Partnership, while keeping vast numbers of US troops and nuclear armaments on their soils. Both clearly benefit from the status quo and don’t wish for the day to come when they have to choose a bundled security-economic dependency with either the US or China, in Cold War-like dynamics.

The stability of the current dual order between the US and China depends first and foremost on the US ability and willingness to provide its Asia-Pacific allies with a security bulwark against destabilising actors (for example, North Korea, ISIS, and the various nationalistic forces). Trump’s isolationist foreign policy may put an abrupt end to this dynamic.
Recent issues in the South China Sea show that China may grow impatient in sharing the limelight with the US. Reuters
On the other hand, it’s still not clear whether China is going to be satisfied with economic dominance alone and with its current geopolitical restraint with its trading partners in the region. China may soon gradually use its trade and investment might to push smaller Asian countries away from their strong bilateral security ties with the US, in exchange for tighter multilateral economic cooperation.

The perfect example of this new dynamic is the recent alignment of the Philippines with China. Philippines President Rodrigo Duterte claimed that “America has lost” both militarily and economically.

China’s elites have long held the view of the US as a declining power and China as its natural heir in the region. Long-established research in political science and economics shows countries rise as they use asymmetric trade relations to turn economic dominance into a military dominance for geopolitical gains.

China’s world trade policy is to assert regional leadership to integrate and upgrade in the global economy. China will eventually seek to translate this trade leadership into regional security and then political dominance also at a global level, as the Asia-Pacific region carries the bulk of world economic growth.

However there is an increasing co-dependency between China and other countries in trade dynamics, particularly in the natural resources sector and in foreign direct investments tied to global supply chains.

On the one hand, this co-dependency restrains China from an exceedingly aggressive foreign policy, but on the other hand is pushing China’s strategic interests out of the Asia-Pacific regional shell. In fact, as early as November 2014, China’s President Xi Jinping openly advanced the idea of a “major-power diplomacy with Chinese characteristics”. In other words, to secure national interests with a more assertive foreign policy reflecting China’s rising economic power.

With Trump’s victory, and also considering the recent issues in the South China Sea, it would be hard to believe that China is going to be satisfied in a dual order under the US security umbrella. The ultimate issue is whether China will decide to pursue hardline policies to push the US outside of Asia in the short term, or instead patiently wait for the US to naturally recede from the region as its economic power wanes.

Before Trump’s victory, there was reason to believe that Xi Jinping and the Chinese government would opt for the latter option. This was because it’s not in China’s best economic interest to ignite geopolitical tensions in Asia, especially as the American retreat may lead Japan to reinstate a significant military capability.

As China currently benefits from a stable, open and secure system of free trade, Trump’s trade protectionist agenda may instead push China towards hardline foreign policies. This would compel its co-dependent trading partners like Australia to soon make a clear choice between the US and China.

Author: Giovanni Di Lieto, Lecturer, Bachelor of International Business, Monash Business School, Monash University

US Consumer Credit Growth Strong

The latest data from the US Federal Reserve shows that consumer credit increased at a seasonally adjusted annual rate of 7 percent during the third quarter. Revolving credit increased at an annual rate of 5-1/4 percent, while nonrevolving credit increased at an annual rate of 7-1/2 percent. In September, consumer credit increased at an annual rate of 6-1/4 percent.

Further evidence supporting a rate rise in December?