Focus
November 08, 2024 | 13:31
U.S. Election 2024: Red Tide
Economics
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Economics
U.S. Election 2024: Red TideDouglas Porter, CFA; Michael Gregory, CFA; Scott Anderson, Ph.D.; Sal Guatieri |
The U.S. election results will shift the economic landscape, particularly if the Republicans also manage to hold onto the House. Indeed, a potential Republican sweep of all three levels of the federal government suggests upside risks for growth, equities and the greenback in the near term, but also increased pressure on inflation and interest rates along with much more uncertainty about trade protectionism. |
The U.S. election results will shift the economic landscape, particularly if the Republicans also manage to hold onto the House. However, there are still plenty of questions around the extent to which the campaign rhetoric translates into policy reality. The lean will certainly be to more tax relief, although the positive growth impact will be countered somewhat by broad trade tariffs and uncertainty, accompanied by a firmer U.S. dollar and higher bond yields. The latter are driven by bigger budget deficits, modestly higher inflation risks, and possibly less Fed easing than previously expected. On balance, this puts some upside risk on our growth call for 2025, and we have lifted our forecast modestly to 2.2%, but tax relief will take time so the major impact on growth may be more of a 2026 story. For the Fed, after trimming another 25 bps from its policy rate this week, a similar decline is likely in December, but we look for a slower pace of rate reductions in 2025, with the terminal rate now likely to land in the 3.25%-to-3.50% range, or 50 bps higher than previously expected. The results are a mixed bag for the Canadian economy and we have not changed our outlook for growth or interest rates. Ultimately, a healthy U.S. economy is the single most important factor for Canada, regardless of who is in charge. While there is likely to be lots of unwelcome trade uncertainty ahead of the 2026 USMCA review, Canada does have relatively well-balanced trade with the U.S., especially aside from oil exports. The Bank of Canada may need to tread a bit more cautiously on the rate cut front given the sustained downward pressure on the Canadian dollar alongside the prospect of less aggressive Fed cuts and a firmer U.S. growth outlook. |
Results |
Donald Trump will become the 47th President of the United States, looking to pick up where he left off in 2020. As of the time of writing, he has 295 Electoral College votes, 25 more than required for a majority, and he holds big leads in the remaining states. He is also likely to win the popular vote. Equally important, the Republicans could gain full control of the government, as they took back the Senate with 53 seats (gaining 4) and have a sizable lead in retaining control of the House with 211 seats to the Democrats’ 199 with 218 the magic number to win. This would give Trump freer reign to implement his policy proposals, as per the first two years of his first term. |
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Market ReactionThe ‘Trump trade’ was in full swing on Wednesday morning, though it faded for bond and currency markets by week’s end. Equity markets ripped higher, led by financials and energy companies, sending the Dow to its biggest daily gain in two years. Corporate credit spreads, already tight, narrowed further. Treasuries were thumped with the 10-year rate shooting 20 bps higher at one point to four-month highs, before reversing after Chair Powell affirmed the Fed remains on an easing path. The yield curve steepened further as investors began pricing in extra inflation risk, lifting long-term rates more than shorter-term tenors. Bitcoin surged to record highs on Trump’s support for crypto currencies. The U.S. dollar took flight, posting one of its largest single-day moves in nearly two years. The Mexican peso was slammed, falling 3% initially, as Trump recently warned of steep tariff increases of at least 25% on Mexico’s sales to the U.S. China’s yuan and the Canadian dollar fell a lesser 1% initially. Oil prices weakened on the stronger dollar and the prospect of increased domestic production (“drill, baby, drill”). |
U.S. ImplicationsIn our October 18th Focus Feature (2024 U.S. Election: Macro and Market Impacts), we laid out the potential macro and fiscal impacts of four possible election scenarios. We can now narrow that down to just two. Scenario 1—Republicans control the White House and both houses of Congress; and Scenario 2—Republicans control the White House, but Congress remains divided. The Republicans have already won control of the Senate, but the House still has a number of seats up for grabs and vote counting could still take days before the necessary 218 seats are decided for control. A Republican sweep, if realized, will likely mean a swift adoption of most of the Trump campaign’s economic policy proposals that are heavily weighted toward tax cuts and tariff increases. First is the extension of nearly all provisions of the Tax Cuts and Jobs Act beyond 2025. An analysis by the Committee for a Responsible Federal Budget estimates that could increase the Federal deficit by $5.35 trillion over ten years. Trump has also proposed exempting overtime and tip income from taxes, ending taxation of social security benefits, repealing the $10,000 cap on state and local tax deductions, and lowering the corporate tax rate to 15% from the current 21%. All told, Trump’s tax cuts and proposed spending increases could add over $10 trillion to the federal deficit over ten years. To help offset at least some of these costs, Trump has proposed a 10% universal baseline tariff on all imports with a 60% tariff on imports coming from China that could help to raise an additional $2.7 trillion in tax revenue. It is estimated the Federal debt held by the public could rise to 142% of GDP by 2035 compared to 125% of GDP under current law. We believe the U.S. economy could see a short-term boost from more accommodative fiscal policy, lighter regulation, and easier financial conditions, but the adverse impacts from higher tariffs, potential trade retaliation, and possibly higher inflation and interest rates could largely offset the short-term gains. The Federal Reserve itself may have to respond to looser fiscal policy by keeping interest rates higher than previously planned or even eventually raising the fed funds rate again to cool what could be another overheating economy. The full impacts of any Trump fiscal policy changes, most notably lower corporate taxes, are not expected to hit the economy until 2026. This outcome will likely require a re-think of our medium-term GDP, inflation, and interest rate forecast from our current baseline. The knee-jerk market reaction to the election results has already kicked off this process. Expect more market volatility as we get further clarity on the priorities and timing of Trump’s numerous policy proposals. As a first pass, we have bumped up our 2025 real GDP growth call by 0.2 percentage points to 2.2%, reflecting a likely lift in business and consumer confidence in anticipation of tax cuts and some easing in financial conditions from a so-far powerful equity market rally. Under a divided Congress (Scenario 2), the full menu of Trump’s extensive tax cut proposals will likely not come to pass, lessening the stimulative impact on growth and reducing the negative impact on the national debt. However, Trump would still likely be able to pass most of his protectionist trade measures as the president has almost full discretion to impose tariffs on nations judged to have an unfair trade advantage over U.S. firms or that pose a national security threat. A broad tariff on all countries, however, could run into judicial resistance. He could also unilaterally pursue broad deregulatory measures across a number of industries from energy to finance. Implementation of higher minimum capital requirements for banks under Basel 3 could be delayed further. Depending on the extent and scope, tariffs could still add to consumer inflation and end up being a dead-weight loss for the economy over time. This would require some upward adjustment to our inflation and interest rate forecasts, and could lead to lower GDP and consumer spending growth than our current baseline forecast over the longer run. |
Fed Policy ImplicationsNo matter how the election results unfolded, the FOMC was already poised to pare policy rates by 25 bps on November 7, and it did, lowering the fed funds target range to 4.50%-to-4.75%. Rate cuts should continue in December before the Fed shifts to a more cautious easing course (e.g., only one action in 2025Q1). This path will reduce policy rates to the halfway spot between their starting point (5.25%-to-5.50%) and the FOMC’s median projection of the longer-run (neutral) level (2.875%) by the spring, a convenient spot to take stock before potentially moving further… or not. The Fed is in a self-described process of policy “recalibration”. The degree of policy restraint is being dialled back to reflect the reduction in inflation already recorded and the confidence that inflation is “moving sustainably toward 2 percent”. And, importantly, to reflect the Fed’s assessment that the last leg in restoring price stability doesn’t require further slackening and weakness in the labour market, and the attendant risk of overshooting the inflation target unless policy rates are reduced—ultimately to their neutral level. However, with Donald Trump winning the White House along with the Republicans gaining control of the Senate and likely holding on to control of the House, fiscal policy is poised to potentially take a more stimulative turn in terms of a string of much bigger budget deficits partly owing to lower taxes. The latter should lead to stronger economic growth also prodded by a lighter regulatory touch. It should also lead to faster inflation also pumped by higher tariffs. Such a stimulative and inflationary fiscal policy scenario should make the Fed less willing to ease monetary policy as much as it otherwise would have, if at all. We reckon the Fed is unlikely to act in anticipation of such a fiscal policy turn or before any post-enactment until early indications of its impact are evident. In fact, Chair Powell confirmed this assumption in his press conference. A new tax bill is likely near the top of the policy agenda with personal tax rates scheduled to rise meaningfully on January 1, 2026. The original Tax Cuts and Jobs Act was signed into law on December 22, 2017. This time around Trump and the GOP will likely be quicker, dimming the prospects for Fed rate cuts extending into 2026. Policy rates now seem likely to bottom in the 3.25%-to-3.50% range, or 50 bps higher than previously thought. Meanwhile, bond yields initially surged in anticipation of the fiscal policy shift. More growth means higher real yields and more inflation means even higher nominal yields, on top of the upward pressure applied by a burgeoning supply of bonds to finance the hefty deficits. Part of the selloff may also reflect the heightened risk to future Fed independence. On balance, among a now higher profile for overnight rates, higher real yields and inflation expectations/risks, and increased credit risk, it’s hard to think of 10-year yields now feeling comfortable below 4% any time soon. |
Implications for CanadaIn the event of a Republican sweep, Canada’s economy might benefit initially from stronger U.S. growth, as its largest trading partner buys three-quarters of its merchandise exports. Energy producers would also rejoice if the Keystone XL pipeline was resurrected (admittedly, a long shot). However, the country could be one of the hardest hit (along with China and Mexico) from a possible trade tussle. Increased uncertainty about tariffs and the fate of the USMCA ahead of the 2026 review could depress capital flows to Canada and weaken domestic investment, likely extending the nation’s productivity slump. Suffice it to say, none of this is good for the Canadian dollar, which is already challenged by faster rising unit labour costs relative to the U.S. While tariffs and a softer loonie might add some upward pressure to prices, potential economic weakness could hold inflation below the 2% target, keeping the Bank of Canada in easing mode. The Bank expects the economy to strengthen on the back of further planned rate cuts, and any threat to its outlook could spur a more aggressive response. This explains the initial relative outperformance of Canada’s bond market to the election results, with yields rising less than south of the border and Canada-U.S. spreads hitting extremes. The BoC slashed policy rates 50 bps in October, but a more cautious path of 25 bp moves over the coming months is more sensible given the post-election uncertainty and heightened risk to the Canadian dollar. The federal government might need to lower corporate taxes to prevent a further loss of competitiveness for Canadian businesses and investment from fleeing south. Canada will also be pushed harder to raise its NATO contribution much faster than currently planned, potentially leading to a higher budget deficit. Moreover, Trump’s pledge to deport millions of undocumented migrants could impede the Canadian government’s goal of slowing population growth should many decide to head north and cross the U.S.-Canada border. These issues will play a prominent role in the coming Canadian election. |
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