The Trump Questions

Now that the dust has settled somewhat following the US election, we can ask more clear-eyed questions about what lies ahead.

That doesn’t mean, however, that we have complete certainty. The only certainty that investors have today compared to the start of the year is that Republicans control both the White House and Congress. Much else is up in the air. There are three important things to bear in mind as we search for the ever-elusive certainty.

Firstly, while we know the broad outlines of the Donald Trump agenda, we don’t know exactly what we will end up with. Trump’s term in office only starts in late January. The next two months will be an awkward interregnum where Trump gets the attention, but outgoing president Joe Biden is still officially in charge. Once sworn into office, the new administration will not be able to implement its entire wish list at once. In many instances, political processes will need to be followed. How implementation is sequenced will matter to markets. If we think back to Trump’s first term in office, 2017 was a honeymoon year of deregulation and corporate tax cuts that made companies more profitable and sent equity prices surging higher. The dollar weakened, and the global economy picked up steam. The trade wars only started in 2018 and were very negative to market sentiment. This time, we might get the tariff increases before the tax cuts.

Even a Congressional majority doesn’t mean everything will be rubber-stamped. Trump does not need to run for election again, but each of the 435 members of the House of Representatives and 33 Senators will be up for re-election a mere two years from now, and they will be well-aware that American voters historically turned away from incumbent parties in the mid-terms. There will also be substantial lobbying from business leaders to protect their interests from extreme policy changes. So here we just need to be patient and see what is delivered, but also be prepared for things to happen at short notice.

Not the only game in town
Secondly, as much as Trump will dominate the headlines, he is not the only game in town. Policymakers in other countries are not going to sit on their hands, and in the US itself, the Federal Reserve will operate independently of the White House. In Trump’s first term, the Fed was on a very gradual hiking cycle after a period of low inflation and weak growth. Eventually, in late 2018, it had gone too far. Credit markets seized up and the Fed was forced into a hasty reversal by early 2019. This time round, inflation has been falling from multi-decade highs, while growth has been resilient.

Clearly beneath the rosy surface there were enough people who were unhappy with the state of the economy and their personal finances to vote the Democrats out of office. This was a trend across the many elections held worldwide in 2024, with incumbent parties losing votes on an unprecedented scale. Therefore, one of the big questions for 2025 is whether these cracks in the shiny façade of the US economy will widen or narrow, and what role the new administration’s policies will play?

Chart 1: US annual consumer price inflation, %

Source: LSEG Datastream

The decline in inflation we saw during 2023 and most of 2024 has stalled out somewhat. This is something the Federal Reserve will pay close attention to, but for now has taken the view that the disinflationary trend will continue to zigzag lower. In a speech last week, Fed chair Jerome Powell noted he expected inflation to drift lower towards the 2% target, but “on a sometimes-bumpy path”. He also noted that the resilient economy “is not sending signals that we need to be in a hurry to lower rates”.

The Fed is likely to cut a few more times but will clearly proceed cautiously. It knows the Trump administration’s policies could be inflationary but cannot respond pre-emptively to plans that have not been implemented yet.

For one thing, there is usually a lag between policy changes and the impact on the real economy, and as noted above, these policies might not be implemented immediately or at all. There is a risk that there is a quiet period on the inflationary front where complacency builds on the part of investors or the Fed (or both). For now, what we do know is that market expectations for rate cuts have been scaled back considerably. Futures markets price in a fed funds rate of 3.8% by the end of 2025, significantly higher than the 2.8% priced in at the time of the jumbo September rate cut, but still lower than what the market expected in April.

Click here to read more...