CICC: Trump 2.0, Accelerating the Return to the "High Nominal" Era

We believe that Trump 2.0 is highly likely to continue fiscal expansion and industrial policies in an effort to achieve re-industrialization in the United States. We have repeatedly emphasized that, against the backdrop of widening wealth disparity, a large fiscal policy characterized by benefiting people's livelihoods and promoting the return of manufacturing is a bipartisan consensus (see "CBO Raises Deficit Rate, U.S. Fiscal Policy Re-energizes" and "Major Asset Classes in U.S. Election Year: Seeking Certainty Amid Uncertainty"). During Trump's previous term, the trend of the U.S. fiscal deficit expanded (Chart 1), and the effective corporate tax rate declined (Chart 2). From the policy agenda in this year's election campaign, the main focus of future fiscal policy will be to extend the individual income tax and business tax provisions in the Tax Cuts and Jobs Act (TCJA), for example, further reducing the corporate tax rate for companies producing in the U.S. to 15%. The Republican Party's advantage in the congressional elections this year will facilitate the smoother implementation of Trump's fiscal ideas. Overall, according to estimates from Penn Wharton, Trump's policies are expected to bring a fundamental deficit of $4.1 trillion to the U.S. over the next 10 years (Chart 3).

In terms of monetary policy, Trump's trade and fiscal policies exacerbate the risk of rising inflation, which may limit the extent of interest rate cuts by the Federal Reserve. At the same time, Trump may also substantially weaken the independence of the Federal Reserve. In fact, from 2018 to 2019, Powell was pressured by Trump's remarks for insisting on gradual interest rate hikes (Chart 4). Trump's political appeal to boost the U.S. economy largely relies on sustained fiscal expansion, and under the recent rising fiscal financing costs (see "U.S. Treasury Quarterly Report: Fiscal Policy Re-energizes in Q3"), this process requires a more dovish monetary policy than actual economic growth and inflation levels, which may further exacerbate inflationary pressures. Powell's second term lasts until early 2026, and Trump has already stated earlier this year that he will not nominate Powell for the next Federal Reserve chair after taking office.

Under sustained loose fiscal policy and insufficiently tight (relative to economic levels) monetary stimulus, the likelihood of the inherently resilient U.S. economy not landing in the next few quarters is increasing (see "After Rate Cuts, How Quickly Will the U.S. Economy Rebound?"). We maintain our view since the 2022 report "Asset Pricing in the Context of Macro Paradigm Shift" that the U.S. economy is entering a period of high inflation, high interest rates, and high volatility, with Trump's return to the White House marking the beginning of an enhanced fiscal dominance period The U.S. economy is accelerating into an "high nominal" era: high inflation, high wage growth, and high nominal GDP growth (see "The Potential Impact of Trump's Policies on the U.S. Economy"). In the new equilibrium of "high nominal," all three parties are pleased: the public is happy with high wage growth, the government is pleased with high nominal GDP growth to help "debt reduction," and the high inflation center means that the Federal Reserve does not have to tighten too much and bear the risk of economic recession (i.e., passively increasing inflation tolerance). Therefore, the new equilibrium of "high nominal" may last for a long time.

Overseas Assets: Pro-Cyclical, Pro-Inflation

Trump 2.0 may accelerate the recovery of the U.S. economic cycle, combined with the rapid dissipation of uncertainty after the election results are finalized, we expect U.S. stocks to maintain an upward trend in the next six months, continuing to favor value and pro-cyclical stocks (see "Second Half of 2024: Asset Implications Under the Rebalancing of China-U.S. Economies"). A series of policies under Trump 2.0 have inflationary and growth-promoting attributes, which may lead to an upward shift in long-term interest rates, suppressing valuation increases, while improvements in economic fundamentals are more favorable for pro-cyclical and value stocks (profit-driven). We reiterate the three main lines of the stock market: 1) Consumer discretionary sectors related to consumption resilience (Chart 5); 2) Durable goods consumption sectors downstream of the real estate chain; 3) Industrial sectors related to equipment investment and the restart of the manufacturing cycle, as well as upstream raw materials and energy sectors (excluding new energy). Among them, equipment investment is expected to welcome a new peak after policy certainty increases (Chart 6, see "Layout for the Restart of U.S. Equipment Investment: Total Volume").

U.S. Treasuries will accelerate steepening. Trump's potential intervention in monetary policy may prompt the Federal Reserve to maintain a relatively loose or not tight enough monetary policy even in the case of re-inflation realization, so short-term interest rates are expected to continue to decline (limited space) or remain low. Meanwhile, long-term interest rates may continue to trend upward under the catalysis of economic resilience and inflationary policies (internal tax cuts, external tariffs, monetary coordination with fiscal policy), exacerbating steepening. We expect that if the U.S. CPI month-on-month growth from October to December continues to exceed expectations, the 10-year U.S. Treasury yield may break above 4.5%, and even rise to around 5%. In the long term, we believe the central tendency of the 10-year yield is around 4.5%-5%, corresponding to a 3-3.5% inflation center and a 1.5% real interest rate center.

Among commodities, copper and oil are significantly affected by the recovery of the China-U.S. economic cycle, and there is a certain degree of uncertainty. The supply-side certainty of copper is relatively greater, and price changes may be more influenced by the supply side. If the U.S. economic recovery exceeds expectations and the Chinese economy stabilizes and rebounds, copper prices are expected to return to an upward channel next year; however, if Trump's tariff policies significantly impact the global recovery process, the upward momentum of copper prices may be somewhat suppressed (to a certain extent, this has already been priced in recently) If the Chinese and American economies resonate upward, oil prices are expected to benefit, but still face uncertainties on the supply side. We are optimistic that inflation, fiscal policy, and central bank gold purchases (Trump 2.0 may exacerbate trade frictions) are likely to jointly drive the structural bull market in gold to continue. (See details in "Gold: An 'Old Framework' Across Paradigms").

The US dollar may continue to fluctuate at high levels. On one hand, Trump's trade protectionist policies (which weaken the trade deficit) and his inclination to promote US economic growth both have a certain uplifting effect on the dollar, and the European economy is relatively weak compared to the US, which may prompt the European Central Bank to cut interest rates more aggressively, pushing up the dollar price. On the other hand, Trump's intervention in monetary policy may suppress short-term interest rates, and the Bank of Japan is normalizing its monetary policy, prompting a return of carry trade funds, which puts a "ceiling" on the dollar.

Domestic Assets: Avoid the Sharp Edges, Focus on Ourselves

The impact of Trump on the domestic economy and assets may mainly come from direct effects through trade tariffs, as well as indirect effects through monetary and fiscal policies. In the short term, Trump 2.0 may have a negative impact on the domestic stock market and exchange rates. However, on one hand, the current improvement in market sentiment under a package of stable growth policies may have a certain hedging effect against the negative factors of the Trump trade; on the other hand, there is still time before Trump takes office and implements tariff policies, and after the last round of trade frictions, China's re-export trade to the US has a certain development foundation, which may alleviate market concerns in the short term. The impact of the Trump trade on the domestic market still exists, but the relatively positive market sentiment may provide a certain degree of hedging against the negative impact. After Trump basically confirmed his election as President of the United States on November 6, the A-share market experienced a slight decline at the end of the trading session, indicating an increase in market concerns about the Trump trade. However, we believe that in the short term, the negative factors of the Trump trade may still have hedging forces to form a balance.

Since late September, under financial easing policies and a package of economic stable growth policies, market expectations and confidence have significantly improved, which may hedge against the Trump trade. We examine the sentiment in the A-share market through turnover rate and dividend premium indicators. Currently, the trading volume and turnover rate of A-shares are significantly higher than the levels before the stable growth policies were introduced. In October, the average daily trading volume of A-shares was about 2 trillion yuan, significantly higher than the approximately 600 billion yuan level before the policy announcement. The turnover rate of A-shares has also significantly increased from the previous 2% to 5% (Chart 7). At the same time, the overall dividend premium in October remained high The dividend premium is the difference between the price-to-book ratio (PB) of all A-shares and dividend stocks. Since dividend stocks are generally considered to have defensive attributes, they tend to perform better when market sentiment is weak, leading to an increase in PB values and a certain premium compared to the overall stock market; conversely, when market sentiment improves, the dividend premium decreases. Since mid-October, the A-share dividend premium has continued to decline, with improved market sentiment boosting the overall performance of A-shares (Chart 8). Additionally, research shows that the performance of small-cap stocks and growth stocks with lower earnings can also measure market sentiment [2]. The good performance of small-cap stocks such as the North Star 50, CSI 1000, and CSI 2000 itself indicates an improvement in market sentiment.

However, in the future, if Trump's high tariffs are implemented, the uncertainty brought to the domestic economy and market will increase, and the performance of domestic assets will depend on the strength of policies and the recovery of fundamentals. Referring to Trump's previous term, there were three rounds of trade frictions with China in 2018 and 2019, corresponding to tariff lists of $50 billion, $200 billion, and $300 billion, respectively. Trade frictions brought phased pressure to the equity market and exports. In 2018, the CSI 300 experienced a phased pullback (Chart 9), while sectors with a high proportion of revenue from the U.S., such as electronics, textiles and apparel, media, and home appliances, all weakened (Chart 10). Subsequently, in the second half of 2019, the year-on-year growth rate of exports declined, with significant drops in the export growth rates of machinery, audio equipment, and parts, miscellaneous products, and textile products that were heavily exported to the U.S. (Chart 11). On the important time nodes of the three rounds of trade frictions—on the day, one week later, and one month later—domestic major risk assets performed poorly, and sectors related to the export chain fell more; the RMB depreciated against the USD; bond assets performed well, with both interest rate bonds and credit bonds seeing a decline in rates (Chart 12).

Trump's trade tariff policy during his previous term has led to the rapid development of re-export trade from China to the U.S. via third countries. Since 2018, direct trade activities between China and the U.S. have weakened, with U.S. imports from China declining, while imports from Southeast Asian countries, including Vietnam, Thailand, and Indonesia, have rapidly increased. The correlation between imports from China to these three Southeast Asian countries and their exports to the U.S. has risen sharply in 2018, 2020, and 2021, respectively (Chart 13). This may involve a "substitution effect" where China's exports to Southeast Asia substitute for exports to the U.S., and U.S. imports from Southeast Asia substitute for imports from China, but more significantly, it reflects a "complementary effect" of China's re-export trade to the U.S. through Southeast Asia. At the same time, under domestic policy stimulus, the domestic real economy has stabilized, and the CSI 300 index has stabilized and rebounded after 2019, with export sectors that have significant exposure to the U.S. also recovering, particularly in the electronics and home appliance industries, as the impact of trade frictions on the domestic economy and market gradually diminishes.

Overall, the performance of the macro economy and capital markets depends to some extent on the strength of domestic policies and improvements in economic fundamentals (see "Embracing 'Half-Inflation' | China's Macroeconomic Outlook for 2025" and "Expanding Domestic Demand is More Important"). China has considerable fiscal space, and monetary policy can continue to be accommodative. Against the backdrop of a more complex external environment, the urgency for policy intensification is increasing.

Authors of this article: Zhang Jundong S0080522110001, Yu Wenbo S0080523120009, Source: CICC Insights, Original title: "CICC: Trump 2.0, Accelerating Return to the 'High Nominal' Era"