The U.S. stock market appears to be a believer in Donald Trump’s Make America Great Again policies. This includes his plan to spend $1 trillion in building highways, tunnels, bridges, and other infrastructure. Trump has long talked about the need to repair the nation’s crumbling infrastructure. He even mentioned it recently in his acceptance speech.
Whether or not the unpredictable Trump will follow through is hard to say particularly given he appears to have backpedaled. The straight-talking business man now appears to know a thing or two about political double-speak.
Less than two weeks after his acceptance speech, the president-elect said in an interview with The New York Times (“NYT”) that his infrastructure proposal is, “. . . not the core, but it’s an important factor.” When pressed by the NYT on whether his infrastructure proposal was a part of his job-creation plan, Trump said:
I don’t even think it’s a big part of it. It’s going to be a big number but I think I am doing things that are more important than infrastructure, but infrastructure is still a part of it, and we’re talking about a very large-scale infrastructure bill. – Donald Trump (November 22, 2016)
Trump also made no mention of his infrastructure proposal last week in his YouTube video that discussed his first 100 days in office. He didn’t even mention building that much-talked about wall along the Mexican border. You can watch that 3-minute YouTube video below.
Nevertheless, let’s assume he does follow through on his $1 trillion infrastructure plan, as the market seems to believe. Is it feasible? And what impact would it have on the U.S. economy?
Regarding its feasibility, we need to consider the supply of construction labor. Construction labor unemployment (seasonally unadjusted) from the most recent quarter ending July 2016 was 4.9%, as shown in the graph above. This was the second lowest level in since the turn of the century. The supply of construction workers is tight to say the least.
Such a tight construction labor market has proven inflationary. Average hourly earnings of production and nonsupervisory employees in the construction industry accelerated to +3.9% YoY in the most recent quarter ended July 2016. As you can see from the second graph above, such a level of construction worker wage inflation is consistent with the end of the past three (3) business cycles. In fact, Federal Reserve Chair Janet Yellen told Congress just two weeks ago:
. . . the economy is operating relatively close to full employment at this point, so in contrast to where the economy was after the financial crisis, when a large demand boost was needed to lower unemployment, we’re no longer in that state. – Janet Yellen, Chair of the Board of Governors, Federal Reserve System (November 17, 2016)
Given the scarce supply of construction labor and the accelerating wage inflation, implementing a large infrastructure bill should prove challenging. Such policies make sense during periods of deflation or disinflation but, as Yellen indicated to Congress, the U.S. is no longer in that situation. It is even more challenging given Trump’s proposal would need to compete with an existing backlog of projects estimated at USD$3.6 trillion, according to the American Society of Civil Engineers in Washington.
As discussed in a previous posting from a month ago titled Will the Federal Reserve Raise Interest Rates?, the federal funds rate looks to be far behind the curve. If inflation spirals and the Federal Reserve is forced to play catch-up, then don’t be surprised to see interest rates rise faster than the market expects.
Don’t Fight the Fed
The President of the Federal Reserve Bank of Philadelphia, Patrick Harker, warned less than two weeks ago that the pace of rate hikes (emphasis added), “. . . may need to have a steeper path . . .” should Trump enact his tax cut and spending plans. Harker will have a vote on monetary policy in 2017.
This sentiment was echoed by the President of the Federal Reserve Bank of Richmond, Jeffrey Lacker, less than three weeks ago when he said, “If a more stimulative fiscal stance would materialize that would bolster the case for raising rates.” He further added:
As a general matter, doing monetary policy with a more stimulative fiscal outlook usually warrants higher policy rates. – Jeffrey Lacker, President, Federal Reserve Bank of Richmond (November 14, 2016)
Federal Reserve Chair Janet Yellen also warned Congress less than two weeks ago that big spending on infrastructure now runs a distinct risk down the road. Running up debt and spending now makes the country less able to use that particularly lever for growth in the face of a future economic downturn. Yellen specifically told Congress:
In addition with the debt/GDP at 77%, there is not a lot of fiscal space should a shock to the economy occur; an adverse shock that should require fiscal stimulus. – Janet Yellen, Chair of the Board of Governors, Federal Reserve System (November 17, 2016)
This could prove devastating to markets if the self-proclaimed “king of debt” is indeed correct about the stock market being (emphasis added), “. . . in a big, fat, ugly bubble.” Trump added that the bubble was fueled by the Federal Reserve, which was, “. . . keeping the [interest] rates down so that everything else doesn’t go down.” If interest rates reverse and accelerate upwards due to spiraling inflation, coupled with ill-timed fiscal spending, then investors may find themselves urgently reevaluating how they should prudently reallocate their capital.
Whether or not you find Trump’s fiscal policies particularly infrastructure will lead to an inflation spiral and markedly higher interest rates, please consult an investment fiduciary before making any investment decisions.