The Day After
2024 saw a record number of the world’s population heading to the polls. The most consequential of those would be the US election. The American people have now made their choice, Donald Trump has won the White House and the Republican Party has taken the Senate having flipped a number of key states. At the time of writing, the outlook for the House of Representatives remains unclear but leans Republican which means the US election is very likely to result in the so called 'Red Wave’.
Initial thoughts on a Republican sweep
The Red wave should allow President Elect Donald Trump to get much of his agenda through Congress. Our view below is split into two broad categories: those policies that require Congressional approval and those that the President can unilaterally push through with executive authority.
Policies that require Congressional approval
Fiscal policy requires congressional approval. However, with a Republican sweep Trump will largely have unfiltered ability to enact fiscal policy as he sees fit. Trump has promised significant fiscal loosening with expectations that the tax cuts passed in 2017 – and are due to expire at the end of 2025 – will be extended. Broad tax cuts, including corporate tax, are likely to increase the budget deficit however this will be partially offset by the revenue raised from increased tariffs. Elon Musk is touted to lead a new agency to bring efficiencies and has proposed cutting spending materially, but this seems unlikely as raising spending is much easier than cutting it. Fiscal deficits, which are already wide, are likely to get wider over the next few years. A Laffer curve1 boost and thus tax receipts are likely to be modest, although there is potential upside to tax revenue if AI boosts GDP materially.
Trump has also expressed a desire to repeal parts of Biden’s Inflation Reduction Act (“IRA”). However, Republican states have been big beneficiaries of the spending from the IRA which makes us think that policy changes around it should be marginal.
Trump has also promised to slash regulation which seems likely with the Republicans likely controlling the House and the Senate.
[1] The Laffer curve illustrates the theoretical relationship between tax rates and tax revenue, suggesting that there is an optimal tax rate that maximizes revenue, with rates either too low or too high leading to decreased revenue.
No Congressional approval required
The President Elect has broad authority to impose tariffs, although this needs to go through a lengthy process which means the time between decision and implementation can be prolonged. Trump may thus announce his intention to impose tariffs and negotiate for a better deal resulting in some of the tariffs not being applied if the negotiations are fruitful from Trump’s perspective. Figure 1 shows that Trump’s proposed tariffs are a lot bigger than those imposed in his initial Presidency.
On the campaign trail, Trump promised to slash immigration, including deporting millions of illegal migrants. Large scale deportations seem unlikely for legal and practical reasons. However, overall rate of immigration is likely to fall although perhaps not by as much as political noise would suggest. Immigration, having surged over 2022 and 2023, has already fallen notably this year.
Separately, Trump has expressed that he wants to be involved in monetary policy which would impact the Fed’s ability to act independently. It is not clear what this means in practice and his room for manoeuvre is likely to be small. Trump has also said he wants a weaker US dollar. With tariffs having the opposite effect, it is unclear what this goal will mean in practise.
Figure 1: US average tariff rate on total imports
Source: Barclays Research. As of November 2024. Note: Assuming Trump’s new tariff proposal of 60% on all Chinese imports and 10% on all imports from the RoW
What does this mean for US growth and financial markets
For GDP growth there is a big increase in uncertainty. Fiscal spending and less regulation are broadly good for growth, although bigger deficits and possibly higher yields may crowd out the private sector investment, thus offsetting the boost from extra spending. Tariffs on the other hand are materially negative for growth and hugely disruptive for businesses. Many believe this will hit growth in both the US and elsewhere, although forecasting error on this is likely high. Also, we cannot be certain that all the mooted tariffs will actually be implemented or whether they will be postured and then withdrawn. Tariffs are unlikely to cause an improvement in US competitiveness as the US dollar will rise to offset what on the face of it seems to be a competitive boost.
Higher tariffs and wider deficits are inflationary in the year the changes are made, but not necessarily thereafter. If inflation expectations remain anchored and monetary policy steers the economy well, then inflation could fall back to target.
In the near term, the Fed is likely to continue to cut interest rates and will not want to be seen as overly political. Many FOMC members will have the view that the neutral point of Fed Funds Rate is well below where it currently is, so further cuts remain a sensible course of action. The Fed will also not want to front-run policies which may not actually happen (i.e. tariffs).
Immediate impact on financial markets
Expectations of looser fiscal policy and deregulation have been received positively by equity markets with the S&P 500 building on strong YTD performance and hitting an all-time high. Small cap equities, a beneficiary of Trump’s previous presidential term, are performing even better. Emerging market equities underperformed.
Expectations of higher fiscal deficit and growth boosting policies have triggered a sell-off in government bonds, which in addition to sizeable upward moves we have seen over the past two months now sees the US 10-year trading at c. 4.45% (September low c.3.61%). The US yield curve has steepened. Inflation breakevens moved higher but we see no evidence of inflation expectations becoming unanchored at this stage.
Higher bond yields coupled with elevated expectations of tariffs have acted as meaningful tailwind to the US dollar, with the trade weighed dollar rallying c.2% overnight, building on the gains of the last couple of months.
Figure 2: Overview of financial markets
Mercer view
Our broad macroeconomic view over the past number of months had been a return to normal. Normal in terms of economic growth, inflation, wage growth, and monetary policy. This would be mildly supportive of risk assets. However, the election results materially increase the tail risks. There are upside risks to growth from tax cuts and deregulation and downside risks from tariffs and trade wars.
There are a number of consequential actions (especially tariffs) that are very difficult to forecast regarding what impact they may have, and the response of China and other countries is largely unknown at this stage. With this in mind and equities at all-time highs, we are likely to stay neutral (having been overweight from October 2023 to October 2024).
The US dollar unambiguously should strengthen further on prospect of tariffs, especially against the Chinese Renminbi, which may be devalued by 20-30% vs the US dollar if 60% tariffs are applied. For China, a Trump administration is unambiguously bearish for exports to the US and inbound investment. Markets might well focus on this in the near term. However, it is possible that China may loosen fiscal policy notably and provide a floor under the housing market. Stronger housing and consumption along with weaker exports (to the US, but not to the rest of the world) may be a positive change for China overall. Tariffs on China are likely a positive for EM ex China.
Bond yields may face some upward pressure, but this is not certain as yields have already moved higher over the last couple of months. While we believe a fiscal ‘crisis’ is low risk, it is not inconceivable if tariffs lead to a ‘bad’ trade war, persistently higher inflation, softer growth and large fiscal deficits.
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November 2024.
