Global markets will be guided by signs of the evolution of Donald Trump's policy positions this week, after his surprise victory in the race for the White House triggered euphoric buying of shares and revived a sell-off in bonds.
Investors cooled their enthusiasm on Friday when Wall Street was broadly flat, setting Australian shares up for a quiet start to the week. The S&P; 500 closed 0.1 per cent lower to 2164.45 points and the Dow Jones Industrial Average added 0.2 per cent to 18847.66 points. Futures indicate the S&P;/ASX 200 Index will open 15 points or 0.28 per cent lower on Monday.
The incoming United States president confirmed his adminstration will shelve the Trans-Pacific Partnership trade deal, indicated he is willing to leave parts of Obamacare intact - a backdown from his campaign rhetoric, and used his victory speech to promise big spending on infrastructure. It has fuelled a growing view in the market that 2016 will be the low point for interest rates and a sharp sell-off in bonds continues its pace.
Ten-year Australian government bond yields finished the week at 2.56 per cent, up from 2.35 per cent before election day. In the US, the moves were even more pronounced: 10-year Treasury yields spiked to 2.15 per cent, the highest since January, having fallen to 1.35 per cent in July. The Australian dollar last traded at US75.46¢, down from US77.39¢ on Thursday. The US dollar index has rallied five days in a row.
James White, a portfolio manager at Colonial First State Global Asset Management, believes Mr Trump's victory only escalated the rout in bonds which began with China's producer prices rising close to a five-year high. That inflationary trend should continue with the appreciation of commodity prices. "This has got probably as much to do with the China PPI [producer price index] as it's got to do with Trump, to be honest," Mr White said. "Trump and a lot of his policies, that gave a lot of follow-through."
Mr White said that in the near-term markets might retrace some of their big moves last week but in the medium- to long-term believes "this is a really big moment in the economy". "If you think about what people have been begging for from a policy perspective, it has been greater fiscal support and clearly that's now going to occur. I think there are limits on what Trump can and cannot do, but I don't think there's much of a limit on what he can do from an economic perspective, particularly if there are substantial tax cuts, that can be easily passed by his congress."
The Republicans will control all levels of government in Mr Trump's first term in office.
Mr Trump's ability to emulate Ronald Reagan will depend on whether the United States dollar takes flight, he said. "The extent to which it's inflationary is really dependent on the US dollar. One of the things that allowed Reagan to spend pretty aggressively was the fact the US dollar appreciated pretty substantially and that softened the inflation blow from really strong wage growth.
"The funding of the fiscal deficit was pretty easy. I tend to think that's Trump's potential opportunity. There may be some interest rate rises, but they won't be as substantial as people think because the [US] dollar will do a lot of the work."
Traders' expectations of a rate hike from the Federal Reserve next month remain at 84 per cent. The US dollar in the past five days rallied against every Group of 10 currency except the British pound, and is up 3.3 per cent against the Japanese yen to ¥106.65.
This week, economists are looking to the first public comments from Fed chair Janet Yellen since election day, and a speech by Reserve Bank of Australia governor Philip Lowe in Melbourne on Tuesday. Australia's unemployment rate, at 5.6 per cent, is updated Thursday.
Bond fund manager Bill Bovingdon of Altius Asset Management said yield curves were "way too flat" implying long-term bond rates were too low relative to short-term rates, a problem which central banks have begun to appreciate. "Our view is that central banks were flogging a dead horse and the side effects of negative rates and QE [quantitative easing] was not only damaging for banks, insurers and pensions but had also made income inequality, which was already a problem, much worse," he said.
"The big unknown is who is going to play ball with Trump? The Republicans are already pointing out that they will have to face mid-term elections so they will not want to alienate their support base [via increased spending].
"Protectionism, infrastructure spending and tax cuts will give a short term kick to the economy but they are clearly going to add to the debt burden and there will be a drag on productivity which could lead to higher prices," the Altius chief investment officer said. The low-point in the inflation cycle, Mr Bovingdon said, most likely occurred last year as energy prices bottomed. It will take longer for the "Trump effect" to be absorbed.
"The real impact on inflation from trade policies, apart from expectations in the financial markets, is going to take 12 to 18 months so this is a pre-emptive move in bond markets."