What a Trump presidency could mean for financial markets

Eight years ago, there was widespread uncertainty as the recently elected Donald Trump began serving his first term as the president of the United States (“US”). Little was known about if and how he would implement his “America First” policies. Policies that would see the US exiting the Paris Climate Agreement, the breakout of a trade war, and an attempted Muslim travel ban. This time around though, the US president-elect is a known quantity. Therefore, we ask if the “Trump Trade” is overblown and if his election is in fact not as consequential for global financial markets as most investors think?

Unlike his first term, this time Trump not only won the presidency, but the Republicans also won control of both houses of Congress. As a result, the Trump administration has considerably more influence to push through policy changes than ever before. Trump’s proposed policies centre around four pillars: deregulation, trade, fiscal, and immigration.

Theoretically, deregulation is both bullish for growth and potentially even disinflationary. Thus, during the first Trump presidency, a period in which the number of economically significant rules published materially declined, one would have expected a noticeable uptick in economic activity. However, despite the Trump administration’s deregulatory stance and implementation of the 2017 Tax Cuts and Jobs Act (“TCJA”), growth in non-residential fixed investment only briefly accelerated above its long-term average – see Figure 1. Potentially because businesses owners on average were already not burdened by red tape. Therefore, even though we expect red tape to be cut in 2025, the magnitude of the positive impact on economic activity may be underwhelming.

   Figure 1 – US capital expenditure briefly lifted above its average in response to deregulation

Another component of the planned deregulation is to simplify the process required to receive oil and gas drilling leases. Trumps hopes are that this will allow the US to become the dominant oil producing country, while simultaneously lowering petrol prices for domestic consumers. Although deregulation could lead to a ramp up in oil production, if there is not a corresponding increase in demand then prices will fall, and US oil producers would see minimal increase in revenue – see Figure 2. Without an economic incentive to perform additional drilling, the deregulation will likely have limited actual impact on economic activity. However, if the deregulation is coupled with expansionary US fiscal policy, the demand for oil could rise and prices would remain stable.

Figure 2 – US oil production typically responds to price, not changes in regulation

Bullish investors are focused on Trump’s potentially expansive fiscal policy

Since the election both US stocks and government bond yields have risen as most investors view Trump’s fiscal agenda as a positive for economic growth and corporate profits. However, we caution that the amount of fiscal expansion to deploy is an important balance to strike. Too much, and inflation could reaccelerate. Too little, and economic growth will underwhelm.

With this in mind, we believe there are three possible scenarios (see Figure 3) that the US budget could follow:

1. • The most conservative option involves congress only extending the TCJA before the end of next year to prevent income taxes from jumping back to the higher 2016 levels. This would only maintain the status quo and offer no fiscal impulse. As a result, we believe that this is a possible, but unlikely outcome as it would mean Trump would fail to deliver on his campaign promise to boost the economy.
   • Alternatively, the most aggressive option would see the extension of the TCJA and the fulfilment of most of Trump’s campaign promises. This would likely cause the budget deficit to grow to 9% of GDP in 2026 and generate fiscal thrust of roughly 2.5% of GDP. Meaning that the deficit would rise to levels last seen post the global financial crisis or COVID-19 pandemic. Given the thin one seat majority that Republicans have in Congress, we believe this too is a low probability outcome. Especially given that the deficit expansion would lead to a significant rise in government bond yields as inflation expectations rise. In other words, the bond market would discipline the government for their abandonment of fiscal prudence.
   • Therefore, the most likely path is one that sees the extension of the TCJA and the implementation of some of Trump’s campaign promises. For example, declaring that overtime and tip income are tax exempt. This outcome would probably expand the deficit by 1% to a total of 7.5% of GDP, and in turn generate fiscal thrust similar to the 2016 to 2019 period.

Figure 3 – Three possible fiscal scenarios

On its own this would be a bullish outcome for economic growth and US corporate profits and would likely lead to equities rising and bonds selling off in 2025. However, there are some limitations. Namely, the expansionary fiscal policy will probably have to be coupled with an increase in tariffs.

Tariffs and their implications on trade

We believe that tariffs are likely to be implemented at some point over the coming year as both the Trump administration and Congress view them as a vital source of revenue to offset the impact of tax cuts on the deficit. Furthermore, Trump can implement tariffs through the executive branch and avoid getting Congressional approval altogether, making it a quick win. If his first term is anything to go by, then he is probably quite serious about using them again.

While we cannot be sure what the tariffs will look like, it is likely that at least one major broad-based unilateral tariff will be introduced next year. This could take the form of a 10% tariff on all US imports or even a large tariff (reportedly as much as 60%) on imports from China. In response, we expect that large trade partners will retaliate with their own tariffs in order to limit the impact on their domestic labour market. Just as they did in 2018.

Between 2018 and 2019 the first trade war led to increased global trade uncertainty, which saw the ISM manufacturing index decline significantly. In response, the S&P sold off close to 20%, the US Federal Reserve responded by cutting interest rates, and long-maturity government bond yields fell prior to 2020 – see Figure 4. Clearly the first trade war was negative for global economic activity and risky asset prices, despite the administration’s deregulatory policies. As Trump’s second term policies are very similar, we have no reason to believe the outcome will be any different this time.

Figure 4 – The first trade war negatively impacted economic activity

In fact, the tariffs proposed by the Trump administration might go well beyond what was implemented in 2018, and at their minimum appear more in line with tariffs last levied in the 1970s – see Figure 5. As a result, if the proposed tariffs are implemented, it could lead to a substantial global shock.

Figure 5 – The proposed tariffs are far more extreme than the first trade war

Immigration reform could be inflationary

During his electoral campaign, Trump vowed to take action to restrict both lawful and unlawful immigration into the US in 2025. While immigration reform is possible next year it would require support from Senate Democrats. However, through the administration’s executive channels, he could and likely will make a concerted effort to deport illegal immigrants. Having said that, processing the deportation of the roughly 1.3 million immigration cases in backlog may take somewhat longer than the administration hopes given the desired time frame.

The administration will likely also focus on requiring employers to better screen job applicants regarding their immigration status, making it harder for illegal immigrants to gain employment in the US. A similar approach was taken during the 2015 European migration crisis, and it led to a material decline in the volume of migrants entering illegally as employment incentives deteriorated.

In the short term, a decrease in the number of immigrants would reduce the supply of labour and could tighten the labour market. However, the impact may be less than many expect as the decline in labour would slow income growth, and in turn employment. In truth, we believe the forces that we have discussed in past Market Synopses will have a greater impact on the path for unemployment in 2025.

Investment takeaway

Considering the Trump administration’s four pillars, we believe that the fiscal and trade policies will be the real market-movers in 2025. While the deregulation and immigration policies pose either more mixed market impacts or longer lags to see economic change.

Given that the proposed tax cuts will very likely be offset with tariffs, which we know from past tariffs are negative for economic growth, we reiterate our bearish medium-term view on equities versus bonds. In our view, the markets discourse regarding the “Trump Trade” and the economic impact of his presidency is not overblown.

If you are interested in finding out more about how cognisance of the macroeconomic backdrop impacts our investment decision making process, connect with Integrity Asset Management and let us help you navigate your investing journey.

For more information on this synopsis or to discuss solutions provided by Integrity Asset Management, please contact us at:

Tel: (021) 671 2112
Cell: 072 513 2684 / 084 601 1025
E-mail: nic@integrityam.co.za / herman@integrityam.co.za

Source: Bloomberg, 29 November 2024