View of Trump economy brightens

Markets seem to think Donald Trump's economic plan could be much better than was thought. Photo/AP

Donald Trump's economic agenda was widely criticized on the campaign trail as a danger to the American recovery. But now, as the first pieces of his plan begin to take shape, experts say it could actually have the potential to deliver major stimulus.

At the forefront is Trump's call for dramatically lowering the tax rate for individuals and businesses, a move long sought by Republicans. After the election, Senate Majority Leader Mitch McConnell, cited tax reform among the priorities for next year.

On Thursday afternoon, Trump had lunch with House Speaker Paul Ryan, who issued his own blueprint for tax reform over the summer.

The likelihood of a deal remains highly uncertain, and the price tag for Trump's cuts is estimated to be as high as $6 trillion over the next decade. But with Republicans in charge of the White House and Congress, the odds appear higher than they were before the election - and that is enough for investors and economists to start recalibrating their expectations.

"The tax cuts and spending increases that are likely to be passed would tend to boost near-term growth, inflation, interest rates and the dollar," said Ben Herzon, an economist at Macroeconomic Advisers.

The shift in outlook is clear on Wall Street, where the bond market has gotten pummeled amid the improved economic outlook. Yields on 10-year U.S. Treasurys - which move in the opposite direction of price - continued to climb Thursday afternoon to 2.1 per cent, the highest level since January. The spike in yields after Trump's victory on Wednesday was the largest since 2013.

The movements reflect investors' expectations that Trump's fiscal stimulus would be likely to increase the national debt, especially if it is combined with massive new spending on infrastructure, which could raise the federal government's borrowing costs.

At the same time, investors also believe the economy will pick up momentum, pushing inflation higher. It currently stands at 1.4 per cent, well below the Federal Reserve's target of 2 per cent following years of tepid economic growth.

But if prices start to rise as the recovery gains steam, the Fed would probably raise interest rates - pushing up long-term Treasury yields even more.

A forecast from Barclays released Thursday shows inflation rising to 2.6 per cent at the end of 2018. Chief economist Michael Gapen said the new analysis assumes tax cuts that amount to 2 per cent of the country's total gross domestic product, larger than those passed by President George Bush but smaller than the package proposed by Trump on the campaign trail.

The estimate also assumes Trump fulfills at least part of his controversial pledge to slap punitive tariffs on goods from Mexico and China and withdraw from free-trade agreements.

Economists have warned that such measures could spark a damaging trade war with crucial partners. The Barclays analysis assumes new tariffs of 15 per cent on Chinese imports and 7 per cent on those from Mexico, lower than Trump has called for but higher than the average duty in place.

"What we believe we know is coming is a shift in policy," Gapen said. "We have a high degree of confidence that we'll get the expansionary policies. The question is what happens on the trade side."

It remains unclear how, when and even if Trump will renegotiate long-standing trade deals. Other key parts of his agenda that could have significant effects on the economy - such as mass deportation of illegal immigrants or repealing the Affordable Care Act - remain a mystery.

But at least so far, investors have been heartened by Trump's conciliatory tone. Wall Street rallied again Thursday, with the Dow Jones industrial average poised to close at a record high.

"These policies will have no impact on the economy in 2017. They won't even be in place. They're all expectational," said Blu Putnam, chief economist with CME Group. "But that's what markets do."