On 14th December 2016, the Federal Reserve Bank of United States of America increased interest rates by 25 bps pulling up the interest range to 0.50 -0.75 pc, which was the second rise in the last 10 years. Fed Chair Janet Yellen, indicated that the rates would continue to rise in 2017, the US GDP for September 2016 is showing strength at 3.2% growth QoQ, unemployment rate is as low as 4.6% and inflation is on the rise at 1.6%. It was the perfect time to raise the rates. However, the Debt to GDP ratio of USA is still at an all time high at 104.17%.
Donald Trump has campaigned for :-
- Spend and invest more in infrastructure
- Reduce taxes from 35% to much lower levels
- Putting in more money in the pockets of middle and lower income class to increase consumption
- Reducing regulations for ease of doing business
- Increase investments in defense infrastructure.
This package seems perfect for investors in the Stock Markets and for a stronger dollar. Given this situation the US becomes the most attractive destination for investment.
As a result the dollar will get even stronger from the current level of dollar index at 102.5. Higher interest rates, growth in GDP and inflationary conditions are visible in the near future.
No doubt, that it is the best situation for US in the short term, where stock markets would rise and bonds would fall due to increase of interest rates and gold would fall too with a stronger dollar.
But what happens to the emerging markets like India ? What seems most likely to happen is outflow of Dollars from the EM’s into the US markets, as the local currencies depreciate against the stronger dollar. This would leave the markets bleeding and further cause dollar outflows, ending up in a vicious circle.
Emerging Markets which include Brazil, Russia, India, China, South Africa etc., are living with a Nine trillion dollar of debt. Keep in mind that this debt is only corporate debt and does not include sovereign debt. As the dollar gains strength, we would be starring into financial crisis, as by implication debt increases in terms of local currencies with no growth in earnings.
When, taxes are cut , interest rates raised due to inflation and spending on Infrastructure and defense increased, it would create huge deficits making the economy inflationary. Inflationary conditions would be good for gold prices as Real Rate of Interest ( Interest rates less inflation ) turns negative.
Deficit acts like Helicopter money. To accommodate the deficit to drive economic activity , both Monetary and Fiscal policies would need to be accommodative. High inflation would compel the Fed Bank to further increase interest rates which could end up US in a Recession. Donald Trump would be called the DEFICIT PRESIDENT if he would do what he has been campaigning , i.e. Reduce taxes and Increase spending.
In Short term, the Stock Markets are looking to race ahead in U.S. and correct in India and other EMs due to dollar outflow. Bonds will fall with rising yields and gold might further correct due to stronger Dollar.