Outlook: Factoring in Trump’s Policies

The return of Donald Trump to the White House next year will very likely bring a whole host of new tax policies, tariffs, and immigration policies that could have a profound effect on inflation, interest rates, the dollar, exports and imports, GDP growth, and the labor market. Indeed, we expect U.S. fiscal, immigration, and trade policies will take center stage in 2025 and 2026, shaping the domestic and global macroeconomic landscape and outlook. We say this even as the Federal Reserve, usually the star of the economic and financial market show, continues to gradually cut interest rates to try and normalize the stance of monetary policy. With the election now behind us, let’s take a minute to review how we are thinking about the risks and opportunities for the U.S. economy, and how we are starting to incorporate some of this new information into our 2025 economic outlook.

This week we modestly bumped up our U.S. real GDP and consumer spending forecast for 2025 (Chart 1). Not only has consumer spending and GDP growth continued to surprise on the high side of expectations, but the Trump victory is likely to at least temporarily bolster consumer and business confidence as well as stock market performance. What is the driver you ask? Trump’s return to the Oval Office and likely full control of Congress by the Republicans means a full and permanent extension of the Tax Cut and Jobs Act is very likely. We have now incorporated this assumption into our current baseline macroeconomic forecast.

More good news on the growth outlook comes from productivity growth. Just this week we received a notable upward revision in productivity gains since 2019, suggesting that the nation's long-term growth potential may be somewhat higher than we previously thought (Chart 2). Add in the potential for stronger capital spending growth and efficiency improvements from AI, and it isn’t hard to imagine productivity growth sustainably staying on a slightly higher growth path than it has in the past.

Trump has proposed a number of additional tax cuts, including lowering corporate taxes, exempting tip income, overtime pay, and social security benefits from income taxes, and eliminating the cap on state and local income tax deductions. These tax cuts could further stoke consumer spending and business investment growth, though they likely won’t arrive until late next year at the earliest, so they have not been incorporated into our 2025 growth forecast and will likely impact our 2026 growth outlook once we have more details on their extent and timing.

The downside of all these tax cuts of course is a rapidly rising budget deficit that could put additional upward pressure on inflation and long-term interest rates. Theoretically, the Fed may need to put its easing cycle on hold prematurely, or even reverse it, if inflation gets out of hand. But again, this is more of a 2026 story than a 2025 one.

A more pressing policy change is likely to be U.S. tariff policy. Trump has pledged harsh tariffs on China (at least 60%), Mexico (25% to 100%), and other trading partners (10% or 20%). These tariffs will immediately raise the cost of imports from these countries, and might give more cover for domestic producers to raise prices, especially if the economy remains strong. Production from heavily tariffed countries would likely shift to third-party countries in Southeast Asia and other emerging markets, adding to supply chain pressures and production costs coming from other countries as well. We know these tariffs will likely push up inflation, interest rates, and the U.S. dollar, but it is impossible to know by how much until we have a better idea of what the tariff rates are going to be on which products and which countries. The tariffs will also like trigger retaliation from other countries that could hurt U.S. exports and production in other sectors, pushing down export growth and holding back GDP and employment growth. Given the uncertainties at this point, we have not yet added tariffs into our baseline GDP forecast. However, tariffs are definitely an important downside risk to our 2025 growth forecast and upside risk on our inflation, interest rate, and U.S. dollar forecasts.

Finally, mass deportations of illegal immigrants are not in our baseline growth forecast for 2025. Until we have more information on the possible scope and cost of such a policy change, trying to put it into our macroeconomic forecast would be a fool’s errand. The macroeconomic impacts appear pretty straightforward, however. Deportations would reduce potential GDP growth and labor supply, reduce aggregate demand, and could push up real wages. In short, mass deportations would likely lead to somewhat slower growth and slightly higher prices and wages than our current baseline forecast.

Bottom line: Our 2025 U.S. growth outlook looks better than it did six months ago, but, as you can see, there are significant trade and immigration policy changes that could soon impact our forecasts, working to reduce our GDP and employment growth projections and push up our inflation and interest rate outlook. In other words, don’t get too comfortable with the current more optimistic 2025 outlook. It’s a decent placeholder, but looming policy shifts from the Federal government will soon disrupt the status quo.

Election 2024: Red Tide

Douglas Porter, CFA; Michael Gregory, CFA; Scott Anderson, Ph.D.; Sal Guatieri

The 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 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.

Results

Donald Trump will become the 47^th 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.

Market Reaction

The ‘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. Implications

In our October 18^th Viewpoint article (“2024 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 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 Implications

No 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 dialed 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 labor 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.