US election: The Trump effect

The economist view – Melanie Baker, Senior Economist

So it looks like we are set for another Trump presidency and Republican control of the Senate. A Trump presidency will likely bring a change in both policymaking style and substance. It still isn’t clear at this point though whether Republicans will also control the House. That matters for prospects of Trump getting his fiscal policies through. Without carrying the House, the focus for now may fall on the tariff and immigration parts of his platform where he has more leeway to make changes without the support of Congress.

No clean sweep? Trump can still do a lot on immigration and tariffs: His less growth friendly tariff and immigration policies (including the deportation of undocumented migrants) seem likely to be inflationary. A stronger US dollar and potentially lower US energy costs can act as a partial offset. On the latter, 2025 is set to see a lot of supply come online for oil, while Trump has vowed to cut US energy costs in half within 12 months of taking office, saying that he will “declare a national emergency to allow us to dramatically increase energy production, generation and supply.” However, the starting point is a recent period of relatively high inflation and where the latest data points for inflation have been a bit higher than would be inflation-target consistent. It seems plausible that pass-through of tariff increases to consumers may be stronger than during the first Trump presidential term.

Trump has said that he will raise tariffs on all trading partner imports by 10-20% and said he will impose a tariff on China imports of at least 60%. He has also said recently that he would impose tariffs up to 200% on vehicles imported from Mexico and impose a 100% tariff on imports from countries that shift away from using the US dollar. Some of this may be more of a negotiating tactic and Trump won’t be sworn in until January so whether that is the case may not be clear for a while, but my assumption is that a large proportion of these tariff threats should be taken seriously. Increases in tariffs can in theory be offset by currency moves but generally any tariff increases are likely to be paid for by a mixture of consumers, importers and exporters depending on the item in question.

Increases in tariffs can in theory be offset by currency moves but generally any tariff increases are likely to be paid for by a mixture of consumers, importers and exporters

With tariffs this broad and of this magnitude, retaliation from US trade partners would seem likely, increasing the likelihood of damage to global growth, with a particularly negative impact on the already beleaguered global manufacturing sector.

As for the impact on the US, the Peterson Institute have estimated that the 10-20% across the board tariffs from the US and the 60% China tariff would cost US families $1,700 or $2,600 extra a year but claim those as conservative estimates, noting the potential for domestic producers to raise their prices too, for example. They point out that Trump wants to levy tariffs on more than 10 times the amount of imports as in his first trade war. More generally, estimates for the impact of Trump’s tariff proposals on US inflation and growth vary, but with some economists cite numbers in the vicinity of an additional 1% on inflation and a bit less than 1.5% off GDP – although presumably if Trump gets his tax proposals through that could offset the impact on US growth.

Potential impact on the Fed? It makes sense for now to expect the Fed to cut a bit less than they would have done, but whether or not this is a Republican clean sweep matters for the likely Fed profile too because it matters for the outlook for US fiscal policy.

Fiscal policy – clean sweep worsens the outlook for the fiscal deficit: If it does turn out to be a Republican clean sweep, the margin of victory also matters (some Republican lawmakers may pushback on some of Trump’s tax proposals for example). The fiscal process may involve substantial ‘horse-trading’ for new proposals to get through Congress either way.

The US has been running a sizeable fiscal deficit already though and with a clean sweep the fiscal outlook worsens. In recent months, Trump has put forward a number of planned tax cuts on top of his plan to extend the tax cuts from his previous administration (otherwise set to expire in late-2025). The Penn Wharton Budget Model in late August estimated the cost at that point of Trump’s tax and spending proposals at $5.8 trillion and Harris’ at $1.2 trillion. According to the non-partisan Committee for a Responsible Federal Budget, Trump’s combination of policies (also including tariffs, military expansion and deportations) would increase budget deficits an estimated $7.5 trillion over 10 years.

In the US, it has been easy to brush away concerns around fiscal sustainability on the grounds that the US dollar is the world’s reserve currency and underlying demand for US treasuries is strong. However, the deficit is large and projected to remain large, while debt looks on an unsustainable trajectory. Neither Harris nor Trump was promising fiscal prudence.

The asset allocator view – Trevor Greetham, Head of Multi Asset

Prediction markets ahead of the US election showed an outcome that could easily have gone either way (Chart 1). Despite this uncertainty, we went into this period maintaining a large tactical overweight in US equities in our multi asset funds. Our rationale was mostly macroeconomic, with technology earnings powering ahead, inflation back under control, the Fed and other central banks cutting interest rates and global growth likely to pick up into 2025. Depressed investor sentiment and a drop in equity markets immediately ahead of the poll created a dip to buy and we added to positions (Chart 2).

Chart 1: Prediction market odds on Presidential candidates

Past performance is not a guide to future performance. The views expressed are the author’s own and do not constitute investment advice. Source: PredictIt Implied Odds, Bloomberg as at 4 November 2024.

Chart 2: Royal London Asset Management investor sentiment indicator and global stock prices

Past performance is not a guide to future performance. The views expressed are the author’s own and do not constitute investment advice. Source: LSEG Datastream as at 1 November 2024.

Initial market reaction to the Trump victory has been as expected, with Wall Street doing well in the expectation of lower taxes and lighter regulation, while Asian and European exchanges have seen heavy losses on tariff fears. We’ve also seen a stronger dollar along with a rise in US treasury yields on fiscal sustainability concerns. Longer term, there are many questions to answer.

Initial market reaction to the Trump victory has been as expected, with Wall Street doing well in the expectation of lower taxes and lighter regulation

Taken at face value, punitive tariffs and the large scale deportation of undocumented workers could raise inflation and trigger a US recession which would hurt stocks. The geopolitical situation has been thrown up in the air, with European governments seriously worried about next steps in the Russia-Ukraine conflict. Meanwhile, enormous US refinancing needs could see further upside to treasury yields if we pass the five-year anniversary of Covid stimulus with deficits as far as the eye can see. US markets aren’t immune to the sort of pressures we saw in the UK mini-budget.

As investors, we’ve been here before. It’s a matter of whether Trump should be taken both seriously and literally. Only time will tell. From a multi asset point of view, broad diversification, including inflation hedges like commodities, can reduce some of these risks. Active management can also help. We stand ready to move to a more defensive tactical posture should the outlook deteriorate.

The bond manager view – Craig Inches, Head of Rates and Cash

Like a phoenix from the ashes…President Trump is back and we will need to strap ourselves in for another four years of unconventional US politics. The market impact will be difficult to call at times, due to the volatility created by the Trump rhetoric and constant public horse-trading. What do we know so far…

Not only did President Trump win the presidency, but he also won the public vote. In addition, the Republican party won the Senate and at time of writing it is not clear if they will have won the House of Representatives, but if they do then a ‘Red clean sweep’ will make it easier for Trump to potentially push forward with his ambitious tax proposals. At a glance, his tariff, tax and extradition policies appear inflationary, but could also impact growth negatively. For markets, this should be reflected through higher yields, steeper yield curves, and higher inflation breakeven. Markets may also become concerned with the sheer amount of borrowing to fund Trump’s economic policies, with the first test being a 30-year auction tonight. However we have already seen these moves play out over the last few weeks on the likelihood of a Trump victory and the big question now is will these moves have further to run or will the market consider future implications for global growth?

I think it will be a difficult path to tread, but what we have learnt in recent years is that markets don’t move in straight lines. What we have also learnt is that bond valuation should not be ignored in a higher yielding environment, and that in a world where global growth could become more challenged, some of the yields currently on offer in sovereign bond markets are starting to look attractive. For example, long-dated Australian, UK and US government bonds are all trading near to or above 5%. Long-dated US real yields trade at 2.25% and even UK real yields look more favourable than they have for quite some time at 1.6% after a negatively received UK budget.

In a world where global growth could become more challenged, some of the yields currently on offer in sovereign bond markets are starting to look attractive

Naturally it’s hard to be 100% certain on the future of bond markets at this early juncture, but the themes of steeper yield curves are likely to continue as economies continue to slow and supply remains high. Trump is likely to be negative for UK and European growth prospects (tariffs), and this could see UK and European bonds continue to outperform the US on a cross market basis. However the likely reduction in US support for Ukraine could see the UK and Europe having to significantly bolster defence spending – putting further pressure on public finances and leading to increased supply. The next few months is unlikely to be dull, but once again volatility is good for the active manager.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.