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As Donald Trump entered the Oval Office for his second term, the initial reaction from markets was positive. US equities believed that he would unleash “animal spirits” within the US economy as a wave of optimism drove investment and speculation. As the first quarter of 2025 draws to a close, the reality has turned out to be quite different. As Starmer/Reeves found out, telling everyone what you are going to do e.g., raise taxes, has consequences for consumer behaviour. Trump is finding out that threatening and talking about tariffs and trade wars is scaring the US consumer. Furthermore, Elon Musk’s Department of Government Efficiency appears to be randomly sacking people in the search for cost savings. This too will have economic consequences, the unemployment rate must rise, putting the US Federal Reserve Bank in a tricky situation. Tariffs will create a short-term boost to the inflation statistics, whilst the rise in unemployment statistics and fall in consumer confidence data will make it look as if the US is close to recession (“the Double-Dip”). For now, the animal spirits have dissipated, US indices are underperforming China and Europe and US bond yields are close to inverting again. Not a great start for the President.
US Consumer Expectations
The economic data across a wide range of industries and service sectors in America is deteriorating. This is creating a renewed growth scare. Possibly, the DOGE job cuts could slow the economy in the near term; tariffs and the threatening language may be another part unnerving US citizens. Business surveys have been downbeat, while the latest Conference Board survey of consumer sentiment, as shown in the chart above, the first since Trump took office, dropped sharply. In his first term, expectations rose immediately, this time, even though his arrival in office has been accompanied by far more “excitement” and action than he generated in the first, it seems consumers are more dubious.
The DOGE
Headed by Tesla founder Elon Musk, his new Department of Government Efficiency (DOGE) has been tasked with cutting enough US Federal spending to fund significant tax cuts or even a direct “dividend” payment. This has been done before under the Bill Clinton Presidency, but this time it is an uphill task. Then, they cut Discretionary Spending (the Grey Line), this time around, that is already low and falling. DOGE will need to slash this to near zero and hope that interest costs fall. The alternative would be to cut Mandatory Spending, which will require approval from Congress. This includes the politically difficult-to-cut Medicaid and Retirement (Social Security) payments. Demographics and increased life expectancy mean that cutting here will be almost impossible. Nevertheless, the actions so far are dramatic and does, perhaps, help explain the rationale behind the geopolitical decisions.
What has gone well?
To counterbalance the negative impact of DOGE on the economy as well as the tariffs, the Trump administration needs three things to move lower before the tax cuts arrive. Interest rates need to fall; this will stimulate consumers to “refi” their mortgages and spend the capital uplift. While the Fed has not formally helped yet, market rates are slowly creeping lower. Lower interest rates will also help Elon Musk’s cost savings plan. If oil moves lower, then so does inflation and that would help minimise the tariff impact. Finally, a weaker dollar would act as a stimulant and reduce the impact of tariffs on US exports. It’s hard, though, to see how a falling dollar can be sustained if the administration moves ahead with big tax cuts and tariffs. Nevertheless, all three have moved lower since Inauguration Day. This is positive not just for the US economy but for most of the other global economies as well.
Geopolitics
It is hard for markets to understand the US geopolitical decisions made since taking office, particularly the removal of support for Ukraine and apparent favour towards Russia. This single action has though done what the US wanted to achieve for years i.e. make Europe deliver its own defence rather than relying on the US. It is also possible that it reflects the view that post-Soviet Russia is no longer a direct threat to America’s interests, unlike China. In an administration looking to cut discretionary spending and a renewed focus on China, it becomes a little clearer as to why the USA appears to be in the process of walking away from Ukraine. For Europe, the military safety net provided by the USA seems to be diminishing. Hence the belated dash to replace US owned military equipment with European ones. The UK, straddled diplomatically between the US and EU it too must also spend a lot more on defence. Economically, this is good, as defence spending gives an immediate return for key manufacturing industries. Who loses? It seems to be renewable energy. It will be hard to stop Russian gas from coming fully back onto the European market, green energy is expensive to establish and the returns are not as immediate as from defence spending. Hence, the move up in European stock markets. Indeed, could this be the economic event that delivers the growth needed to bail out Rachel Reeves? The repurposing of the National Wealth Fund to include defence spending is a creative move that should deliver immediate returns for the UK economy.
Markets
February saw the once-dominant Technology sector, led by the “Magnificent Seven” sell off and “the Rest” finally start to move. The catalyst seemed to be Microsoft cancelling leases for data centers. This one move led to a reassessment of the future returns from A.I.. Is it 2000 all over again, or just markets being efficient as cheap non-technology companies started to grow again? This immensely complex period for the investment markets is continuing. The tariffs and the trade war seem to have finally arrived, thus marking the beginning of a period of bad economic news for the US economy. The data from here for both inflation and unemployment can only get worse. Bond yields will have to reprice what might appear to look on the surface like a recessionary environment. Possibly even for the “double dip” recession, which based on history, is due round about now. No one is expecting the Fed to raise interest rates based upon what will be one-off factors, however, there is always the risk of unintended consequences. US Government spending in 2024 was more than the entire GDP of third-ranked Germany. Musk is looking at cutting $2 trillion, i.e., about the same as the GDP of Italy! On its own, a cut of this scale is capable of tipping the US into recession, however, the savings, if then distributed to industry and consumers, would provide a staggering transfer of wealth from the State to the private sector. So it is not the cuts, but the time between spending cuts and distribution of the savings that will be the issue. Now that the tariffs are here, the markets can start to move on and look to the second part of Trump and that is the tax cuts. The end results should be economically very good it’s just the journey that could be messy.
