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The Trump shock - How worrying is the global market reaction to the American

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Nov 14th 2016, 17:38 by R.A. | WASHINGTON

IT HAS not yet been a week since Americans elected Donald Trump their next

president, and already there is a lot to digest. While Mr Trump's initial

personnel decisions deserve plenty of scrutiny, the global market reaction to

the election also demands attention.

This morning, the decline in bond prices that began last week continued. In

America, the 10-year government bond yield rose above 2.26%, the highest level

since the end of 2015, while the 30-year bond yield reached 3%. Treasuries are

faring worse than many other bonds, however. Yields are going up nearly

everywhere, but emerging markets and the euro-area periphery are experiencing

especially large moves. (It is, as my colleague Buttonwood quipped on Twitter,

a "Trump tantrum".) What is happening here, and why?

The conventional wisdom is that markets are pricing in an expected move toward

expansionary policy in America. Mr Trump is expected to cut taxes dramatically,

increasing the American budget deficit, while also spending more on

infrastructure and defence. That boost is coming at a time when America's

economy, while still operating short of potential, is nonetheless humming along

as close to capacity as it has been in a decade. Unsurprisingly, inflation

expectations are rising.

One important question which needs answering is: through what channel are these

expected shifts affecting markets more broadly? It is possible that markets

reckon American reflation will boost global demand, leading to higher

expectations for demand growth and inflation elsewhere. It is hard to be too

confident in this story, however. Equities around the world are up a little

since election day, but not wildly so. And while some commodities have done

relatively well in recent days, like copper, most have slumped.

While Mr Trump's plans might deliver an inflationary impulse, there is another

force at work, the effects of which could swamp any American fiscal stimulus.

The Federal Reserve, while it remains independent, is not going to tolerate a

big rise in inflation. Markets are revising upward their expectations for rate

increases over the next 18 months; at the moment they reckon that the fed funds

rate will be 50 basis points higher than it currently is by the middle of 2017.

A faster-than-expected pace of tightening in America typically sends shockwaves

around the world economy. And indeed, the dollar is on a tear.

At several points over the last few years, economists have found themselves

worrying that monetary tightening in America and a rising dollar, coupled with

a slowdown in trade growth and flat to falling commodity prices, could generate

serious financial difficulties for emerging markets with lots of

foreign-currency debt (public or private). The Fed has found itself forced to

tighten more slowly than it would have preferred as market jitters threatened

to feedback into the American economy, slowing its recovery. But a blowout

stimulus push by Mr Trump could change this dynamic, leaving a Fed which

remains determined not to tolerate much of an inflation overshoot with little

choice but to raise rates multiple times. That, more than a turn toward

protectionism, could pose a serious short-term threat to economies around the

world.