Economic Commentary

What might a second Trump presidency mean for the economy?

Opinion polls and political betting markets suggest that former President Donald Trump will beat his rival, incumbent President Joe Biden, to win the US presidential election in November1,2. This is forcing investors to consider what a second Trump presidency might mean for the economy. 

Voters are optimistic on this front, with polls indicating that Trump is trusted more on economic issues than President Biden. Although Biden has presided over strong post-pandemic growth and a recent fall in inflation, he is blamed for the ongoing high cost of living and the erosion in real wages suffered in recent years.

In Trump we trust

Against this backdrop, it is perhaps not surprising that voters view the Trump presidency of 2017-21 as a period of relative prosperity. Despite dire predictions for the economy under Trump’s leadership, the tax cuts of 2017 fuelled a period of decent economic growth (at least until the pandemic came along), as both household consumption and investment rose3

Moreover, strong gains in after-tax profits drove a stock market boom which, along with rising house prices, made households feel wealthier4. Importantly, wages grew in real (i.e. after inflation) terms during the first Trump presidency. In contrast, as a result of the post-pandemic surge in inflation, real median earnings are currently still below levels prevailing at the time when Biden became president in January 20215.

These positives appear to have made a more lasting impression on the public psyche than the failure of the Trump administration’s trade policy (which involved the imposition of tariffs on a range of products including steel, aluminium and washing machines, and a broader trade war with China) to achieve its aims of reducing the trade deficit6 and boosting domestic employment7.

The question going forward is whether a second Trump presidency will be as benign as the first, and whether voters’ trust in his ability to manage the economy is warranted. In this regard, this month’s commentary focuses on three key policy areas in which a second Trump presidency could make a big macroeconomic impact: trade, tax, and the Federal Reserve.

Higher tariffs

Take trade first. Under a second Trump presidency, there is a significant risk that tariffs will be expanded beyond those put in place during his first term (most of which have been kept under the Biden administration). Trump has floated the idea of imposing a 10% tariff on all goods imported into the US (a sharp increase from the current average import tariff rate of 2.0%8), as well as putting a tariff of 60% on all imports from China9

The precise economic impact of such levies would depend on a host of factors, including how trade partners adjust their prices in response, the potential to switch to domestically-produced goods, and the extent to which countries retaliate with tariffs on American goods. Even so, prices for a range of products from electronics to clothing are likely to rise. Although Trump has claimed that America’s trade partners will pay the tariff, the reality is that US consumers will, via higher prices. One estimate suggests that an across the board 10% tariff would cost each American household an average of US$2,000 a year10

This could have broader macroeconomic consequences. If workers attempt to secure wage increases to compensate for lost purchasing power, higher labour costs could further fuel inflation. In turn, this could cause the Fed (the US central bank) to raise interest rates, with negative ramifications for debt servicing costs and economic activity. 

Some domestic US companies that compete with imports and do not rely on imported inputs might benefit from Trump’s tariffs, because their products could become more competitively priced relative to more expensive foreign products.

This could potentially lead to increased sales, higher profits, and even job creation in certain industries. However, over the longer term, such barriers to trade could have a detrimental impact on the economy, as companies shielded from competition would have less incentive to innovate and improve productivity. 

Moreover, US exporters would suffer if, as appears likely, America’s trade partners retaliate with tariffs of their own and trigger a trade war. Estimates from the Tax Foundation (a non-profit, non-partisan research organization) suggest that if other countries retaliate in kind, the effect of a 10% tariff would be to shrink the US economy by 1.1% and threaten more than 825,000 US jobs11. Smaller, more open, economies that trade with the US are likely to suffer an even larger hit proportionately.  

A further decoupling with China, via a 60% tariff and other trade barriers, would further compound these negative effects. According to estimates from Bloomberg, a 60% tariff would reduce the share of US imports that come from China to near-zero12, from around 14% in 202313. This would hit the Chinese economy at a time when it is already suffering from deflation and an ongoing property crisis. Bloomberg reckons the biggest hit would be seen in textiles and electronics, industries where China is currently a big market player and where slim margins would make it unfeasible for companies to absorb the 60% tariff.  

The subsequent shift in production away from China would benefit South-east Asia and Mexico according to Bloomberg’s simulations. This said, under a scenario of a full-blown global trade war and heightened geopolitical tensions, there would be few winners.

Tax cuts

Another priority of a second Trump administration is likely to be tax cuts. Initially this is likely to involve the extension of the temporary tax cuts enacted in 2017 (which are due to expire at the end of 2025), and then possibly more reductions thereafter. Trump’s capacity to do this will crucially depend on whether the Republican party also gains control of Congress after November’s election, which is far from guaranteed.

Further fiscal easing after the election would carry risks. Sure enough, tax cuts could provide a fillip to economic activity and the equity market as they did under the first Trump presidency. However, given the parlous state of the public finances, they could also unnerve the bond market, which has become more sensitive to debt issuance in recent years.

When Trump became president back in 2017, government borrowing costs were relatively low, with the benchmark 10-year US Treasury bond yielding around 2.5%. Fast forward to today, and the yield is around 4.3%14. Moreover, the budget deficit is already historically high (at 6.2% of GDP in 2023, vs. 3.4% of GDP in 201715), and estimates from the Congressional Budget Office (CBO) suggest that extending the Trump tax cuts could add US$3.5 trillion to the deficit over the next 10 years16.

With debt levels already projected to rise sharply (the CBO currently sees the debt/GDP ratio rising from 99% in 2024 to 116% of GDP in 203417), increased debt issuance and the upside risk to inflation from fiscal stimulus could put further upward pressure on bond yields. Indeed, some observers have warned that concerns over the sustainability of public finances could see the US experience a similar bond market crisis to that seen in the UK in 2022, when the government of then Prime Minister Liz Truss tried to introduce unfunded tax cuts18

Fed meddling

A potential conflict between fiscal and monetary policy under a second Trump presidency could put the independence of the Fed under pressure. During his first term as president, Trump was critical of the Fed for raising interest rates, arguing that tighter monetary policy could disrupt the economic recovery.  If he is elected for a second term, there is a clear risk that he will again try to influence Fed policy. Trump has said that he would not reappoint Fed Chair Jerome Powell when his term ends in 2026, and the suspicion is that he would appoint a 'yes-man’ who would conduct policy in accordance with the administration’s political objectives.

The implication, given Trump’s desire to boost growth, is that the Fed, under the chairmanship of a Trump ‘puppet’, would set monetary policy too loose to control inflation. This is particularly significant considering that, as we have seen, Trump’s trade and tax policies could generate inflationary pressures.

If the Fed’s independence is called into question, it could have serious repercussions. If people start to doubt the Fed’s commitment to its 2% inflation target, inflation expectations could rise, driving up US bond yields. In turn, the associated increase in government borrowing costs could lead to pressure from the White House for the Fed to introduce a form of quantitative easing (QE) or yield curve control (where the central bank buys bonds in order to keep yields low). Such a turn of events could put downward pressure on the US dollar and result in a period of financial market volatility.

Early days yet

All of this suggests that Trump’s policies could have negative repercussions for the economy. On the domestic front, it is easy to envision a scenario where a second Trump presidency, characterised by increased tariffs and tax cuts, leads to higher inflation and larger budget deficits. From an international perspective, the risk of a trade war, most notably with China, would rise, and geopolitical tensions, which are already elevated, could shift up another gear. Trump’s ‘America First’ stance and his scepticism towards NATO and other multilateral organisations could potentially make for a more unstable world.

However, none of this is inevitable, and a lot can happen between now and the election. A continued improvement in the economy could swing the polls in Biden’s favour. And Trump still has to overcome several hurdles before he returns to the White House, not least the various legal cases he faces. Surveys suggest that more than half of voters in swing states would not vote for Trump if he were convicted of a crime19.

Moreover, a good deal of what Trump is saying on the campaign trail could prove to be posturing, rather than concrete policy measures that end up on the statute books. Dire economic predictions for the first Trump presidency failed to materialise; investors will be hoping that current concerns regarding a second Trump presidency are also misplaced.    

20 February 2024