Donald Trump has won the US election. He will find the economy strong in some ways with unemployment low and inflation falling, but he will also face a large deficit that will – or perhaps should - curtail plans for large tax cuts or large spending
initiatives.
The Republican party appears likely to control all three arms of Government in the US (Presidency, House and Senate). This will allow Trump a comparatively free rein over US government policy.
Bond markets have reacted to the news with interest rates rising over the course of election day but the move hasn’t been too large and certainly not as large as the one that accompanied Trump’s first victory in 2016. Instead, we see it as
an extension of the move over the past few weeks, where Trump’s win became progressively more anticipated by markets. There has also been a steepening of US curves (10 year yields rising faster than 2Y yields), implying a risk of longer-term
inflation or a risk that Government borrowing requirements are so large as to test market depth.
The change of President from Biden, to Trump, will see a material change of policy, but it also won’t be immediate. First things first, of course, the President elected now doesn’t take power until 20 January 2025. Even the new policies Trump
is able to impose “on day 1” will take some time to alter the trajectory of the economy – for good or ill.
The market is still expecting the FOMC to lower rates and to do so consistently. A full rate cut is still priced for the FOMC meeting this week and a further 90bp of rate cuts over the balance of the next year. That pricing sees the implied FOMC rate
fall from the current 4.88% to 4% by mid-year and to 3.70% by October.
The interesting thing about the priced interest rate profile from here is that it would represent an almost-mythical soft-landing. Compare the shape of the curve in 2025, where the entire cycle is expected to be around 200bp, peak to trough, with the cycles in 2001, 2008 or 2019.
Those first two cycles, 2001 and 2008, were cycles where there was a serious problem in the economy, we had both the tech wreck and the GFC (known as the Great Recession in the US). The 2019 cycle is more interesting. It superficially looks like the previous cycles in that the drop is quite significant, but that’s because COVID intervened. In reality, the 2019 part of the US cycle was moderate and the rate had fallen from 2.375% to 1.625% before COVID hit. It’s not clear how the 2019 cycle would have developed in the absence of COVID. Maybe it would have been a soft landing where the Fed left rates unchanged for a long period.
Maybe it might have been a cycle that resembled Australia, where unemployment was reasonably low, but there was just not enough inflation to justify increasing rates, and every so often, further rate cuts were needed.
Or maybe the 75bp of rate cuts delivered would have been all, and the next move would have been up. The US CPI rate was up to 2.3% in February 2020. A small cutting cycle that gave way to rate hikes is what happened in 1998.
The overall position in the United States is fairly strong. Economically, the two pain points for people (and voters) are inflation and unemployment. While the unemployment rate in the US is very low, the inflation rate remains higher than would be best
and has been very high in recent memory.
Although the generally accepted memory of the economy in the first Trump presidency is fairly positive, it will be a formula that will be hard to repeat. In 2016, Trump inherited an economy that was running smoothly and, importantly, had a fairly low
Government deficit in the scheme of things, allowing a large tax cut.
That’s not the case now. The US economy is running reasonably smoothly but the deficit remains very large. A large tax cut hitting the economy in 2025 might land quite differently than the previous version did. The risks of inflation reigniting and causing the FOMC to reverse course within a year or two are quite real. Bond markets can be very forgiving of changes to government policy – until they aren’t. When the sting in the tail comes it can come hard and fast.
The UK experienced a brief bout of “bond vigilantism” during the short-lived Prime Ministership of Liz Truss. The US situation is more resilient than that because the US is still the strongest single nation on earth and they have more fiscal latitude than the UK. But the same dynamics are stalking the background. The steepening of the US bond curve is a material development. It shows bond markets are reacting to Trump as much more than simply a tax cut that strengthens the economy in the short-term.
As Trump retakes the Presidency, he might find that managing the economy in 2025 is a little harder than it was in 2017 – or at least that it requires a very different approach. The overall situation for the US is good. Unemployment is low and inflation is falling. However, there is very little scope for large tax cuts to be comfortably absorbed. There is comparatively little spare capacity in the US economy to absorb the increase in consumption and comparatively little space in the US Government balance sheet to absorb the increase in borrowing.