Deutsche's 2017 Outlook Weighs Trump's Upside Against Brexit Downside

For politicos, 2016 was a tale of two populist shocks: Republican real estate mogul Donald Trump's victory in the U.S. presidential race and Great Britain's decision to leave the European Union.

In 2017, the fallout from those two votes will play a pivotal role in determining economic growth in much of the western world, according to assessments from Deutsche Bank (DB) economists. A stimulus from President-elect Trump and the Republican-controlled Congress should drive expansion by U.S. businesses and consumers, which will, in turn, benefit U.S. trading partners. 

In Europe, however, the benefits of that growth will be pared somewhat by confusion about how and when Great Britain's departure from the 28-member bloc will take place.

"The key thing for Europe, as you all know too well, unfortunately, is political uncertainty," Torsten Slok, Deutsche's chief international economist, said in a conference with reporters Thursday in New York. Still, he said, "sentiment is coming back with Trump, and sentiment is very important for the outlook because we're hoping it will unleash the animal spirits."

Indeed, markets in the U.S. have already surged since the Nov. 8 election, with the Dow Jones Industrial Average and the Standard & Poor's 500 each reaching record highs.

"The Trump election was a game-changer," said Joseph Lavorgna, chief U.S. economist for Deustche. "It brought fiscal policy back into focus. Consensus had determined, and I think rightly so, that that was significantly paralyzed."

In government circles, fiscal policy refers to attempts to boost the economy through government stimulus, typically via tax cuts or spending on infrastructure such as highways and bridges. Such measures were virtually sidelined due to Congressional wrangling with Democratic President Barack Obama for six of his eight years in office.

Republicans took control of the House of Representatives in 2010, two years after Obama was elected, and regained the Senate four years later.

While it's still difficult to say what contours a stimulus might take, "you have to assume it will be something of some scale, simply because Republicans have both houses," Lavorgna said. "That's something Reagan didn't have when he was inaugurated in 1981 and Bush 43 didn't have when he was inaugurated in 2001."

Ronald Reagan, the 40th U.S. president, and George W. Bush, the 43rd, both pushed economic stimulus programs early in their terms. Reagan's was intended to end the economic malaise of the 1970s and Bush's to curb the effects of the dot-com bubble bursting.

"There's a lot of room for compromise and for there to be a lot less gridlock," Lavorgna said. "If you overlay that, at least tonally, with what will probably be a somewhat more friendly regulatory backdrop, you can see how the animal spirits of the cycle change and how this really does alter the outlook."

The growth-friendly policies most likely to be green-lighted under Trump and a Republican Congress are tax cuts, probably based on the outline in House Speaker Paul Ryan's blueprint, and easing some of the federal regulations that were tightened under the Obama administration, Bank of America (BAC) economists said at a conference last week.

Ryan's plan, published in June, suggested cutting personal-income tax brackets from seven to three and capping rates at 33% instead of the current 39.6%. Corporations would fare even better, with rates lowered to 20% from the current 35%, the largest reduction in U.S. history.

That won't eliminate the overhang of generally slower growth in western economies than in the past three decades, however, a trend that consulting firm McKinsey & Co. has said is largely due to an aging population and declining productivity gains.

And while the stimulus will probably help overseas companies that supply U.S. businesses and consumers, it won't eliminate the political challenges in Europe, where the central bank has approved negative interest rates to encourage banks to lend.

There, "2017 looks set to be a year to be endured rather than enjoyed, at least for the first half, when the heavy political calendar and related uncertainty" is likely to curb growth, Deutsche chief economist Mark Wall said in a note to clients on Wednesday.

Great Britain appears likely to start the process of leaving the European Union as soon as March, and "an economic cost seems unavoidable," Wall said. The clearer the cost, however, "the more salutary the warning to others tempted to exit. It will be some time before we know if the EU gets the balance right."

That could be of crucial importance in France, one of Europe's three biggest economies, where presidential candidate Marine Le Pen of the National Front is promising a referendum like Britain's on leaving the European Union.

Elections are also scheduled in Germany and the Netherlands, and an early election is possible in Italy, "each with different concerns over the influence of right-wing populists," Deutsche economist Patricia Wruuck said in a Wednesday note.

"Trump's win could further embolden nationalism in Europe, fueling fragmentation and bedeviling concise responses to Europe's challenges," she added.

The risks to the region's economy shouldn't be overstated, however. Its businesses are in much better shape than generally realized, Slok told reporters Thursday.

"There is an under-appreciation of the strength of Corporate Europe and the strength of the European economies simply because it's overshadowed so much by the political challenges that continue to be such a headwind," he said. "That doesn't mean political challenges are going to create recession."

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