US Election 2024 and the impact of Trump 2.0

Political events are front of mind during 2024 (e.g. US, UK, France) and we recently provided some commentary on the UK and French elections. However, of these three elections, the US is by far the most consequential given the uncertainty about the result, the differences in the policy proposals of each side and the overall economic and financial materiality of the US. Contrast that with the UK where the results were far more certain and Labour has committed to the existing fiscal rules.

In general markets are pretty bad at predicting political events and their economic consequences. For example, when Trump was elected in 2016, markets were first surprised and fell, before deciding that his proposed tax cuts were good for equities and markets rallied. One reason for this is that there are big differences between:

• What candidates/parties have to say to get nominated or elected
• What they plan to do once in power
• What they are able to do once in power, recognising the institutional, political and economic constraints they face.

Trump 2.0 what are the market risks?
Investors are facing a period of uncertainty, noise and static in the runup to the US election on 4 November, with pundits on each side predicting dire economic consequences if the other party wins. Republicans slate Joe Biden’s deficit spending on greening the economy while Democrats cite the risks of unfunded tax cuts by Donald Trump. But how high are the stakes, and how can investors tune out the sound and fury and focus on the changes most likely to drive markets?

Winning control of Congress matters as much as winning the White House because domestic policy changes require legislation, which requires a workable control of both the House of Representatives and the Senate to pass it. A split government would reduce the stakes significantly, limiting Trump’s power to change spending and tax policy. We’ll therefore focus our discussion on a Republican sweep scenario, because this outcome would likely bring about the most change.

High stakes
One place where stakes are high is the federal budget deficit, which hit 8.8% of GDP last year—more than double the 50-year average of 3.7% (source: Congressional Budget Office) leaving significant room for fiscal expansion. Neither Biden nor Trump could be described as the austerity candidate, each having pushed through trillions of dollars of deficit spending during their terms in office. Whilst we expect deficits to stay high in most outcomes, we would expect Trump to be less cautious about keeping the deficit in check.

The highest-stakes deficit spending item under a Trump White House would relate to his flagship Tax Cuts and Jobs Act (TCJA) of 2017 —a major overhaul of the US tax code, including cutting the corporate tax rate from 35% to 21%. Many provisions of the TCJA are scheduled to expire in 2025, and Trump has pledged to make the entire deficit-financed tax-cut law permanent: a move that the Committee for a Responsible Budget estimates would cost $4 trillion over the next decade. Trump has advocated additional cuts too, including a further reduction in corporation tax from 21% to 15%. Critics say Trump’s tax plans would fuel inflation by stimulating an economy already at full employment.

It's likely that Trump will seek to fund some of his policies by repealing Biden-era climate expenditures. Trump has been particularly critical of the Inflation Reduction Act, mocking wind power and electric cars and describing the climate law as the “biggest tax hike in history” (source: Politico). The race is therefore on for Biden to Trump-proof his legacy by getting as much clean energy spending over the line as possible before the election.

Potentially the biggest wild card is Trump’s support for the notion of bringing independent agencies under presidential control (Source: New York Times). This would raise the stakes significantly if applied to central bank independence. Fed independence is a key anchor for the economy and markets so if Trump (for example) attempts to fire Powell in short order, or seek to change the Fed’s mandate, this would likely trigger turbulence, particularly at a time when markets are recovering from a series of inflation shocks and digesting high issuance, alongside the prospect of quantitative tightening.

Uncertain stakes

Predicting outcomes is complicated by the tension between Trump’s hyperbolic rhetorical style and his often transactional behaviour in office. The market impact would likely depend on the extent to which either of these tendencies won through. For example, will Trump really put a blanket tariff of 60% on all Chinese imports and more than 100% on electric vehicles? Previous behaviour suggests these threats should be taken seriously. Will Trump carry out the “largest domestic deportation in American history”? This is perhaps less clear, given the logistical impediments and potential impact on labour supply. Will Trump withdraw the US from Nato? He could, but it’s likely European leaders would seek a deal to keep the US engaged.

Bond market implications

The US is on a negative fiscal trajectory given its high deficit and the debt needed to finance that shortfall, and bond market participants have become more sensitive to issuance pressures in recent months. As discussed, a Republican sweep would likely put upward pressure on the deficit. The US’s ability to repay its debt is not in question given a massive tax base, a vast domestic and international investor base for US Treasuries, and its capacity to print dollars. The issue is the yields at which the government can issue debt. If the policy mix becomes strongly stimulative, either via tax cuts or extra spending, this would create excess demand in a supply-constrained environment, which would fuel inflation and put upward pressure on Treasury yields and bond risk premia across the curve.

The high-stakes scenario is one in which a combination of elements—pressure on the deficit, a tightening labour market balance, rising import prices and higher inflation—pushes up bond yields in a non-linear way. The important question for equity investors is whether this will happen, and how it would propagate through the financial system.

Equity market implications

Bond markets are potentially the fulcrum around which the equity market turns. Rising bond yields would be a headwind to equity returns as higher interest costs took their toll on earnings and equity valuations were subjected to higher discount rates. That said, while we think the risks to bond yields under a Trump presidency are likely upward, it’s also possible that these upward pressures could be offset if inflationary pressures subside.

In the event of a Republican sweep followed by a big tax stimulus, it’s possible to build a positive scenario for equities where corporate tax cuts would boost earnings, and household consumption and consumer confidence improve, further boosting earnings and reducing risk premia. But while cutting the corporate tax rate to 15% would increase profits and provide a tailwind for equities, it might not pack as much of a punch as the previous initiative. The TCJA changed the way multinational companies were taxed, effectively reducing the rate many companies paid on income earned abroad, so this had a big repatriation of foreign earnings element which favoured low-capex, high cash mega caps. This resulted in a slew of share buybacks and fuelled a big run-up in equities. There might not be as much of a sugar rush this time around.