How might President Trump's policies affect inflation? originally appeared on Quora - the place to gain and share knowledge, empowering people to learn from others and better understand the world.
Answer by Siddharth Pathak, Financial Analyst, on Quora:
Trump's election itself did cause inflation expectations to change. Paul Krugman probably hates this fact more than anything in the world, but by merely winning the election, Trump pushed up inflation expectations.
Breakeven inflation as indicated by the spread between nominal 10 year and 10 year TIPS (inflation linked US treasuries)** surged ahead in the month of November. Though the cynical will probably say that the bottom occurred on Feb 11, 2016. Fair enough, but the reasons behind the market's 180 degree U-turn in Feb are still present, and are part of what Trump and the changes represent. More on this elsewhere.
Fed's 5 year forward expectations index also shows a vigorous pick up in expectations.
This spread is especially interesting - because the bottom is June end - Brexit. Brexit and Trump's election carry similar reasons behind their wins. It isn't a coincidence after all that Nigel Farage, pretty much the single largest contributor to the EU referendum happening, occupies a close position with President Trump. Brexit pushed up inflation expectations upwards - and if this is indeed the bottom of the 35 secular bull market in bonds, it will probably mark as one of the major political event which reflected the bottoming of the cycle. And in the same spread, one can see that the election of Trump finally caused expectations to be pushed above the universal "target" rate of 2%.
This pick up is also reflected in rising corporate yields.
Short term rates had already begun to turn, albeit incrementally. That jump in 5 year, 10 year and 30 year yields is again, a reflection of Trump's victory.
30 year mortgage rates also picked from ~3.5% to 4.3%, a rise of 80 bps, merely because Trump won. He hasn't done anything, except do his favourite thing - which is to win, and the rates picked up by a large magnitude.
This is all a reaction to the fact that he won.
It isn't as much that his policies will break with the conventional policy making that will trigger a pick up in inflation. Inflation was already going to pick up at some point - you can't run an economy at 0% interest rates forever before getting slaughtered by hordes of angry people and kickstarting a revolution (though, one can argue that the election of Trump was one such revolution, though thank God no blood was spilled). Interest rates reflect a connection between the present and the future, and depressed rates imply an expectation of bleak future.
There is evidence that inflation had begun to incrementally rise. If anything, my calculus classes have taught me how few comprehend the importance of incremental change and its compounding effects over time. The fact that not everyone is Warren Buffett, despite his principles not that different from the bargaining strategies of grandmothers is probably an evidence of this.
Commodity prices, despite the fall in crude prices, have picked up. Iron ore and copper, two of the most widely used metals, have been picking up.
And the rise in iron ore prices becomes more pronounced in certain specific exchanges. In Dalian for instance, the price of iron has jumped from RMB 232 per ton in Jan 2016 to RMB 639 in Jan 2017. Copper too, has surged from $2.06 to $2.53.
Reflecting this pick up in commodity prices, mining stocks have surged this year.
Rio Tinto, BHP Billiton, Anglo American and Glencore are amongst the largest miners in the world. The rise in their prices isn't speculation - for quite some years now the miners have been cutting their capex spent on developing on newer mines, which pushes down supply, better reflecting the demand, and since there are less amounts of metals available, the prices pick up due to the supply and demand laws, which is what is happening here.
Higher commodity prices invariably lead to other companies having to pay higher for their inputs, which in turn pushes their expenses. For instance, white goods sector uses a lot of steel and copper in making the motors and casings for ACs, washing machines and ovens, and a pick up in input prices leads to raising the prices of those goods. And in more important sectors, say agriculture, the impact is even more inflationary. A farmer faces an increase in the price he has to pay for the shovel and other farm equipment, which in turn leads to him raising the price at which he sells his produce.
The increase in prices pushes up inflation.
Trump's policies are quite inflationary - that is, if he acts on what the expectations are. Although it remains to be seen what will be the spending on newer infrastructure projects, but the ethos of Trumpianism is quite inflationary. Trade wars interfere with organic linkages between economies, naturally pushing up the price.
And one can't help but sense that the world is undergoing a profound shift from one political order to another, and this uncertain time period is going to see increased political tensions. Using the stick as a negotiating tactic works, but there is also the flipside of the other side calling bluff and doubling down on a hard stance, pushing both sides to war. The probability for conflicts are high in a world undergoing a change in its political order, and with this in mind it is important to note that many of the countries are very ill prepared for them. Germany doesn't have an effective military force, the US politicians in their obsession with a very naive Hollywood-esque view of military technology have created bloated and dysfunctional weapons system (The WWII-Era Plane Giving the F-35 a Run for Its Money), Japan doesn't have a fighting army, South Koreans have subsidized much of their defense to the US, and the European nations are all dependent on an out of control NATO which is in the business of a provoking war with Russia for no apparent reasons. The possible end of Atlanticism, and possible return of the Jeffersonian libertarian isolationist streak of America will push the European countries to begin to rearm for the uncertain future that is beckoning.
This is all inflationary, because this will cause a surge in demand, and employment.
Donald Trump is a reflection of many underlying currents that have been shaping up for quite sometime now. It is just that with the election of Trump, they have been put under the spotlight, albeit relatively because looking at the media reactions to Trump and to Brexit, it seems to be the case that they still haven't understood the crux of the issues, instead just shouting that Trump is not presidential. There are lot more important things happening now, and the fact that Trump speaks in a crass way, or spends a lot of time talking about crowd sizes in his inauguration should be the least concern.
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