Burn, baby! Burn!
The election of Donald Trump is fanning the fires on all fronts: politics, society, the stock markets… The economy and the geopolitical environment will doubtless follow, once he officially enters office on 20 January 2025.
The fire has already reached markets: since the election, US large caps are up by over 4% as of 14 November, whilst the global index excluding US stocks is down 2% in dollar terms. In contrast, rates are tightening, reflecting investors’ fears for inflation, and the dollar is appreciating against all currencies.
But these global moves are nothing in comparison to the deflagration unleashed in the hotbeds fanned directly by the Trump revolutionary wind. Not just on Tesla which – electrified by the inclusion of Elon Musk in the presidential team – has leapt by close to 40% in one week after the election. But especially, and in a much more systemic fashion, on the major banks, which have risen by 11%. And the smallest banks by even more, up 13%.
The reason for this is simple – Trump is promising to slash regulation across the board. Although nothing firm has yet been said regarding the financial sector, the market is expecting to see an easing of the prudential requirements to which banks are subject, or at the very least, no further tightening, as would have been the case had he decided to apply the Basel III rules aimed at strengthening the regulatory framework for banks in the US. We could even see the destruction of a large part of what remains of the regulations put in place in the wake of the 2008 financial crisis via the Dodd-Frank Act adopted in 2010 during the Obama presidency. This law increased supervision of the banks, requiring them to hold greater reserves to avert crises and moderate risks taken in markets. Yet during his first mandate in 2018, Trump had a law adopted to ease these restrictions. In particular, the threshold for close supervision by the US Federal Reserve (Fed) was raised to banks with USD 250 billion of assets from USD 50 billion previously, reducing the number of banks subject to this supervision from 38 to 12.
Whilst banks themselves (or at least their shareholders) are doubtless celebrating at the hope of additional easing, will the US economy – and in a knock-on effect the global economy, since the financial world is closely interwoven – really benefit from this? In the short term, it is possible that credit growth and investment in the economy may receive a boost. Even if, truth be told, the US economy – with the possible exception of the commercial real estate and infrastructure sector – has little need of additional stimulus at present, already supported by Joe Biden’s Inflation Reduction Act, a record budget deficit, growth of close to 3%, and expected rate cuts from the Fed. But, especially in the long term, the destruction of the firewalls established by Dodd-Frank risks making the economy more vulnerable. The recent regional banking crisis is proof of this. Relieved of certain restrictions following the Trump reforms of 2018, some small and medium-sized banks saw their solidity threatened by the rise in interest rates at the start of 2023. Four of them, including Silicon Valley Bank and First Republic Bank were placed in receivership. At the time, the regional banks index lost 30% in a matter of weeks. Luckily, the damage was contained by the contribution of the mega-banks and the Fed, and with yet another swing of the pendulum, supervision of small banks was then strengthened.
Has Trump learned the lesson from this crisis, which his 2018 reforms indirectly facilitated? That’s doubtful currently, when deregulation appears to be his favourite battle cry. Worse still, the reticence to regulate banking risk could spread to Europe. According to the Governor of the Banque de France, François Villeroy de Galhau, Europe could be tempted to roll back implementation of Basel III to avoid suffering excessively from the competition from US financial institutions, relieved of numerous safeguards.
A policy of regulatory bonfires – just like the “Drill, baby, drill” policy[1], will thus certainly succeed in stoking the economy in the short term, and bringing a sparkle to the start of the Trump II mandate, but the extent of the celebratory fires will determine the volume of ashes to be swept away later.
Final version of 15 November 2024 – Alexis Bienvenu, Fund Manager, LFDE