- Consumers, business community highly optimistic
- Many economists remain skeptical about economic boosts
- Worst for industrial sector may be behind us
- Real effects of Trump initiatives may not be felt until 2018
Newly elected President Trump's victory has generated a wave of optimism that lower taxes, increased infrastructure spending, and a rollback in regulation will help spur the U.S. economy to better growth. Not only has the stock market risen to record highs, but consumers, small business owners, homebuilders, and manufacturers are all feeling more optimistic. However, most economists are more cautious, raising their GDP forecasts for the year ahead slightly at best. At the center are differing views of how much stimulus we may get and how effective it will be at this stage of the business cycle.
We believe enthusiasm over near-term economic growth prospects may be warranted to a degree, as long as Trump does not follow through on his more extreme anti-globalization/anti-immigration campaign rhetoric. After ten years of sub-3.0% gains in GDP, the economy would undoubtedly benefit from tax reform, as well as from policies designed to lift its productivity and potential growth rate. But how much and how soon remain open questions. Budget realities may limit the scope of stimulus, while the interplay between political dealing and the legislative process means policy implementation generally involves lags before real economic benefits materialize. As a result, any fiscal boost likely will turn out to be a more important story line in 2018.
Research also shows that the powers of fiscal multipliers are significantly smaller during economic expansions than during downturns. With the economy already operating at or near full capacity, policy stimulus can fuel inflation and trigger increases in long-term interest rates, undercutting potential gains in real growth. Indeed, while the exact nature and size of fiscal change ahead remain uncertain, tighter financial conditions can thwart economic growth. Increases in bond yields since the election have been passed through to mortgage rates, while corporations are now experiencing higher borrowing costs, and export-oriented firms are contending with a stronger dollar.
Mr. Trump has certainly been dealt a favorable hand. After a disappointing first half of 2016, the economy (which is now experiencing one of the longest expansions in recent history) appears to have regained some momentum, and underlying economic fundamentals remain relatively solid. In fact, the strong likelihood of a large fiscal stimulus being enacted over the next few quarters means the near-term risk of a recession is probably as low as it has been for several years. But investors should also be realistic. In the end, we suspect markets may wind up underwhelmed by the stimulus reforms enacted in Washington.
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