Dollar mixed after Trump's inauguration speech

Financial markets gave a relatively muted response to Donald Trump’s inaugural speech as US president, with US stocks holding in sight of record highs, longer-term treasury prices trading lower and the dollar easing back against its main rivals.

Mr Trump’s victory in November fuelled a strong rally for US stocks and the dollar and a steep sell-off for Treasuries amid a surge of optimism that his promises of fiscal stimulus, infrastructure spending and lighter regulation would bolster economic growth and corporate earnings and prompt a faster pace of US interest rate rises.

January 20, 2017 will mark the historic inauguration of what promises to be a highly unconventional US presidential administration. On that day, President-elect Donald Trump will be sworn-in as the 45th President of the United States, thrusting into the forefront all of the ambiguous anticipation over the future trajectory of the nation that has built-up in the past few months. While many Americans remain bitterly divided over the prospects for the new US government under Trump, however, the financial markets have spoken rather loudly and clearly since the real estate billionaire was elected in early November.

Market Run-Up to Inauguration

Market reverberations in the aftermath of the November election have perhaps been most pronounced in the US equity markets and the US dollar, both of which found good reasons to rally on high expectations sparked by Trump’s ambitious economic promises. At the same time, the price of gold entered into a sharp dive as stocks and the dollar rallied, but has recovered much of those losses since the beginning of the new year.

US equity markets, especially, have been enamored with Trump since his election victory, as they have been buoyed to progressively higher all-time highs by bold promises of US economic growth, boosted fiscal spending, lower corporate taxes, and financial deregulation. Meanwhile, the dollar also rose sharply and gold plunged initially on increased interest rate expectations that have been driven in large part by Trump’s well-publicized promises.

Market Outlook after Inauguration

From Inauguration Day onwards, the many growth-inducing promises that Donald Trump has made, which have helped equity markets surge to sharply higher all-time highs, will begin to matter much less than the actual actions taken to fulfill those promises.

Markets are typically prone to rise on lofty expectations and fall on less-than-lofty realities. If the realities under President Trump fail to match expectations with regard to fiscal spending, lower taxes, financial deregulation, or other market-related issues, the many investors who have fully bought-in to the “Trump Trade” could potentially be in for a rude awakening.

What makes the outlook for equity markets and the US dollar potentially even more vulnerable to downside risk after inauguration is that much of the soaring market expectations for the incoming Trump Administration have already been pricing-in to the rallying stock market and US dollar for the past two months. The sharp Trump Rally has essentially made the assumption that these expectations will be fulfilled. If any challenges to fulfilling these expectations arise, which should be inevitable in any brand-new administration, the likelihood of market pullbacks, corrections or reversals increase substantially.

Market Challenges

The potential challenges for the incoming Trump Administration and the financial markets after inauguration are many. Most of these challenges relate to the new government’s ability to set in motion the actions needed to fulfill Trump’s promises, and the potentially resulting market implications.

Time to Implement – Even if all of Trump’s market-related promises eventually come to fruition, they are all likely to take quite some time to implement. With everything that Trump and his team wish to do, both on the political and economic stages, many of the promises most anticipated by the markets will likely be placed on the proverbial backburner for the time being, including lowered taxes and financial deregulation.

National Debt – Trump’s much-talked-about fiscal spending and stimulus plans will not likely create immediate economic growth benefits, while they are expected to add substantially to the already-astronomical national debt.

Congress – All of Trump’s economic policy plans will require close coordination and cooperation with Congress. The good news is that a new Republican majority in both chambers of Congress should smooth out many difficulties. What may be uncertain and potentially challenging is how thoroughly the Republican majority will end up cooperating with Trump in helping to fulfill some of the more controversial aspects of his agenda.

Trade Policies – While many of Trump’s promised economic policies are indeed seen as market-positive, his stances on international trade are widely-viewed as extreme. Trump’s highly protectionist policy positions have the potential to ignite trade wars. This could create a backlash against US companies doing business abroad, and weigh on company revenue and earnings.

Higher Interest Rates - As inflation expectations have risen, so have higher interest rate expectations. Rising interest rates may help support the dollar and banking institutions, but they also increase borrowing costs and financing constraints for most other businesses.

Dollar Strength – If it continues to rise on higher interest rate expectations, a strong US dollar could serve to inhibit growth of US companies selling goods and services abroad, thereby pressuring equity markets.

Clearly, there are many valid reasons for the extended Trump Rally recently seen in stocks and the dollar. Most of these reasons are tied to expectations of a business-friendly, pro-growth president in Donald Trump. While these expectations may ultimately be fulfilled, many near-term challenges and obstacles stand in the way of their fulfillment. As a result, the weeks and months after inauguration are very likely to bring significantly increased market volatility – which has been persistently low of late – as the incoming administration is thrust into its new and unfamiliar role. This volatility could indeed disrupt the strongly trending moves seen post-election and pre-inauguration, and should result in a return to substantially wider two-sided swings in equities, currencies, and commodities.