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Donald Trump proved to be victorious in the US Presidential Election, it was widely forecast to be a close contest, but the reality was very different. Trump eased to victory, winning a rare combination of the Presidency, both Houses of Congress, and the popular vote. The economic and market implications of this landslide are only just starting to be seen. The initial reaction was that US Treasury Bonds fell, leading to higher interest rate expectations (not good for markets). The US dollar strengthened (also not good for markets), global equities fell (especially in Europe and the Far East), green energy stocks fell, as did crude oil prices, while US small caps, US banks and industrials, cryptocurrency, and Tesla shot up. The length and breadth of this list highlights just how complex the implications for Trump’s second term of office are likely to be. What markets cannot do is draw comparisons with the President’s first term of office. Then, he filled his Cabinet with the great and good of Wall Street and US corporate life. This time, he has chosen like-minded individuals and vociferous supporters of his policies. It is these policies that markets will have to digest. Some will be positive for markets, others negative. The planned tariffs will take all the headlines, but it is the impact of Trump’s plans on the US National Debt that is the most important.
US Treasury Bond Yield and the US National Debt
US Debt to GDP shot up during the Covid-19 pandemic and has remained stubbornly high and above the important 100% of GDP level since then (the UK is at 97%). Debt needs to be funded and markets tend to demand a higher rate of interest the higher the level of debt. This rate then sets commercial loan and mortgage interest rates. Since the election results, US Treasury Bond yields have risen from 3.8% to 4.5%. Why? Trump plans to extend the 2017 tax cuts and go further with additional cuts, which will increase the deficit significantly. These cuts could be partly offset by proposed tariffs on imported goods. However, these measures could result in the deficit increasing by approximately $5.5 trillion. This would push the debt to 143% of GDP by 2035, assuming growth remains at current levels.
However, there are two further variables in play. Firstly, Trump’s tax cuts are highly likely to accelerate growth. If growth accelerates, then the GDP part of the formula gets greater. Secondly, there is the desire to cut US Government expenditure. The appointment of the world’s richest man, Elon Musk, to cut US Government spending could have a significant impact given his track record at Twitter. Plans include cutting the $500bn annually in unauthorised federal expenditure; cutting the federal workforce; eliminating programs such as International Aid; cutting defence spending and streamlining bureaucracy. However, achieving Musk’s initial goal of saving $2 trillion annually will be extremely challenging, as that represents about 30% of total federal spending. Big costs such as Social Security and debt interest payments, cannot easily be reduced. Overall, the plan is classic “Thatcherite” austerity, but then again, even Margaret Thatcher could not reduce government spending. Musk’s probability of success is likely to be low, hence the move up in US interest costs, but achieving even a fraction of the planned cuts will have a significant impact on the deficit.
US Inflation.
For investment and global markets US inflation is the key to everything. Low inflation means interest rates can stay low and growth accelerate. Since the post Ukraine shock, inflation globally and crucially in the US has fallen below the 3% benchmark, which is fine. Inflation turned out to be the key factor in the Democrat’s defeat with Biden and Harris taking the blame. Trump will thus be politically sensitive to inflation. However, his proposed economic policies could potentially exacerbate inflation rather than reduce it. Several key aspects of his plans are likely to contribute to inflationary pressures. Trump has proposed imposing substantial tariffs on imports, including up to 60% on Chinese goods and up to 20-25% on imports from other countries. These tariffs could increase costs for American consumers as businesses pass on the higher prices of imported goods. Furthermore, Trump’s plan for mass deportations of illegal immigrants could lead to labour shortages, potentially driving up wages, a big issue for the US Central Bank.
So Trump’s plans are seen to be inherently inflationary, however, if we do look back to his first term then the picture is not quite so clear.
Tariff…..”the most beautiful word.”
During Trump’s first term, tariffs were introduced on some Chinese goods, with washing machines in the first wave. With the majority of white goods sales in the US handled by just a few US mega retailers (Walmart, etc.), the 20% import duty was simply passed on to US consumers. This caused a shift upwards in the price trend, subsequently, as buyers went on strike, prices resumed their earlier deflationary trend. So the evidence suggests that there could be a one-off jump in inflation, but it should not fundamentally change the inflation outlook. Much depends on the power of the retailer and whether the supplier or the consumer pays the tax. Furthermore, in compensation, fuel/energy costs will fall as Trump pumps more oil.
Levying a duty on imports into the US is central to Trump’s economic and other policies. Before even taking office, he announced that he’s going to impose an extra 10% on goods from China and 25% on all products from Mexico and Canada. However, for the latter, he has linked the tariffs to immigration and illegal drug imports. Tariffs are thus being used as a negotiating tool for a wide range of foreign relation strategies, not just to raise money. The reaction of Mexico suggests that overseas governments have learned, maybe it’s easier to promise Trump what he wants and thus allow him to move on? The following table shows the 10 most impacted countries from the imposition of tariffs. Those in green have a free trade agreement with the USA.
China even with a 60% tariff would be in 25th place with an estimated 0.2% hit to GDP and the UK in 27th place again with an estimated 0.2% cost to growth. These are only estimates and are dependent upon how sensitive US consumers are to price increases arising from tariffs, For example a UK export of an Aston Martin/Bentley/Rolls Royce is likely be far less sensitive to tariffs than say a BMW or Renault. For companies, they do have the option of moving production to the US. However, they might find it tricky to get workers. Though to be fair the emphasis seems to be on illegal workers, there has been no suggestion of restrictions on work visas or Green cards.
US Market reaction
The market reaction, while overall positive, was actually very mixed. Europe and China were seen as big losers under Trump. US Bonds worryingly fell as fears about inflation and thus interest rates had to be priced in. The dominant technology leaders were ignored as the economically sensitive banks, real estate and small-capitalisation companies were seen to be the big winners from a Trump economic boom. This is the conundrum for markets, many of his policies are negative, but can be ignored if growth is high. Tax cuts and deregulation are just what the equity markets want and the probability of a boom in the US is now high, which is in marked contrast to Europe. China is following its own economic path, its future growth is in its own hands and not Trump’s and no doubt more stimulus is coming. The tariffs are not that material to the Chinese economy. What we can say is that from before the election, the inflation outlook has marginally deteriorated (though remains positive) and interest rates are modestly higher, however, the growth outlook has taken a big step up. As the year draws to a close, markets are waiting to see if the Fed cuts rates as promised in December, or if they use Trump as an excuse not to. The usual year-end Santa Rally normally arrives after Options and Futures Expiry, which this year is on the 20th of December, just after the Fed announces.
December 2024
