Why They Stayed Calm and Carried On
By SCOTT SUMNER who is Ralph G. Hawtrey Chair of Monetary Policy at the Mercatus Center at George Mason University and Professor of Economics at Bentley University. Follow him at the TheMoneyIllusion.com.
This article was published in Foreign Affairs on November 13, 2016.
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World financial markets have had an unusual reaction to the unexpected U.S. presidential election victory of Donald Trump: they remained relatively calm and, some might say, even responded positively. Unlike the British pound after the Brexit vote, which tumbled rapidly shortly after, the U.S. dollar, after Trump’s election, actually strengthened modestly against foreign currencies such as the yen, the euro, and the yuan. Interest rates in the U.S. treasury bond market have increased, in both nominal and real terms. Inflation is also expected to increase modestly.
The reaction of global equity markets was perhaps the most surprising of all. U.S. stock futures fell as much as five percent on Tuesday evening, as it became apparent that Trump had all but secured a victory. The behavior was consistent with the pre-election pattern. Whenever polls showed an increased chance of a Trump win, stocks tended to dip (as they did following reports that FBI Director James Comey would be reopening an investigation into Secretary Hillary Clinton’s emails). But a few hours after Tuesday’s decline, stocks beat expectations and crept back up. By the end of the next trading day, the market was above pre-election levels.
It is not clear why stock investors responded in this way. Some suggest that Trump’s conciliatory victory speech on Wednesday eased investor concerns. Prior to the election, stock investors were worried about the populist aspects of Trump’s campaign. After the election, investors seemed to anticipate possible supply-side reforms, such as tax reform and deregulation for important industries, perhaps reflecting the fact that the GOP was (also rather unexpectedly) able to maintain control of both the House and the Senate.
It is important, however, not to read too much into these initial market reactions. To a greater extent than usual, investors are unsure as to exactly what the president-elect will do. Whatever one thinks of Trump, he is clearly not a normal politician. In addition, although the various shifts in the market were sizable for a single day, they did not dramatically change asset prices, such as bonds or stocks. The U.S. Treasury yield, or the interest rates that the government pays on new debt, is a bit higher than before, but overall, we still live in a very low interest rate environment. And since markets are forward-looking, these asset prices don’t just reflect the current reality, they also reflect the impact that Trump’s policies are expected to have on future asset prices. This means that the market consensus does not, at this time, anticipate that Trump’s election will significantly affect the government’s ability to repay its debt or for U.S. companies to generate profits, for example.