Tuesday’s election upended not just the political consensus but also the market one. In the aftermath, one investment theme has dominated: reflation. Specifically, this suggests that after several years of fiscal austerity and several decades of declining inflation, these trends are on the cusp of reversing. If so, what does this mean for markets?
Since the election, investors appear increasingly convinced that a Trump administration will lead to higher inflation, and potentially higher growth as well. By Thursday (10 November 2016) U.S. 10-year inflation expectations—based on breakevens in the TIPS market—had soared to 1.90%, the highest level since the summer of 2015.
Besides the impact of aggressive fiscal stimulus that President-elect Trump has proposed, inflation expectations are rising on the back of fundamental developments that preceded the election. After declining for 18 months, oil prices have been stable since the spring. More importantly, core inflation has been steadily creeping higher on the back of a sharp acceleration in medical costs and higher housing inflation. This is important as these components of inflation tend to be “stickier” and larger than energy prices.
In addition, wages are starting to rise: U.S. average hourly earnings have accelerated to 2.8% YoY from a prior level of 2.7% in September. And among the lesser-noticed results from Tuesday’s election, four states voted to raise the minimum wage.