Trump 2.0

Trump’s clear and swift victory in the US presidential election has prevented turmoil in financial markets and, more importantly, political violence in the streets. The close race that pollsters had predicted did not materialize, and contested elections and violent demonstrations were averted. The election uncertainty that remains is which party will control the House of Representatives, but the Republicans appear to be on cruise control to keeping the majority. In this note, we take a brief look at the election outcome and what this means for our forecasts. We then discuss the implications of a second Trump term for the economic outlook and the Fed.

While pollsters predicted a close race, with several heavyweights even calling a Harris victory, voters dealt a devastating blow to the Democrats (and these pollsters). Trump won all seven swing states and the popular vote. In the Electoral College, he won 295 votes (270 needed to win) against 226 for Harris. In the Senate, there will be at least 53 Republicans (51 needed for a majority) against at least 45 Democrats. In the House of Representatives, 211 Republican seats are already certain, and the GOP appears to be heading for at least the 218 needed for a majority. The Democrats will have at least 199 seats. Currently, the Democrats still have a majority in the Senate, while the Republicans control the House of Representatives. Therefore, we move from a situation of “divided government” to full Republican control. Trump is returning to the White House and the Republicans are gaining a majority in the Senate, while keeping control of the House of Representatives.

The 119th Congress will convene on January 3, 2025, and Trump will be inaugurated as 47th President of the United States on January 20. With simultaneous control of the White House, the Senate and the House of Representatives, this offers considerable scope for Trump and the Republicans to implement their policy agenda. The filibuster does allow the Democrats to block initiatives that require a supermajority of 60 votes in the Senate, but if the Republicans keep their ranks closed, they can achieve a lot on many issues. Keep in mind that the MAGA movement has increased its grip on the Republican Party. They already have the House Speaker and Trump is surrounding himself with loyal followers instead of the Republican establishment that kept him in check during much of his first term in the White House. For at least two years, Trump and the GOP could implement much of their policy agenda, until the midterm elections in 2026 would allow voters to flip the Senate or the House of Representatives if they are not happy with the Republican reign. However, in 2025 and 2026, Trump and the Republicans have a strong mandate, supported by a majority in Congress and the popular vote.

We have been forecasting a Trump victory and higher import tariffs since February, when Biden was still on top of the Democratic ticket. Given the strong economic data at the time and Trump’s sustained lead in the polls, we assumed this was as good as it was going to get for Biden and that was not good enough. While Biden’s deteriorated condition must have been known within the Democratic elite, it took a disastrous televised debate in June to remove him from the presidential ticket, after financial donors put pressure on the Democratic Party. Instead of an open election before or at the Democratic National Convention, Vice President Kamala Harris was promoted to the top of the ticket by the inner circle. Supported by a lot of media hype, she started to rise in the polls, but we remained skeptical about her ability to beat Trump. We thought that The Harris Bounce in the polls was likely to fade. In the end, the polls overestimated Harris’ popularity and the voters decided they were done with the Democratic policies of the last four years. Instead of a return to normalcy after the tumultuous Trump presidency, they got a range of policies they did not bargain for and a 20% rise in prices. In hindsight, the Trump years – although chaotic – did not look so bad after all to the majority of US voters. The result was a clear victory for Trump, one that had not been picked up by the pollsters. They claimed that it would be a very close race, and in fact tended toward Harris in the last few days before the elections. However, since we stuck to our baseline assumption of a Trump victory, we do not have to overhaul our economic and rate forecasts.

What does a second-term Trump administration mean for the economic outlook? When it comes to trade, we are likely to see new import tariffs. Trump has repeatedly talked about a 10% to 20% universal tariff, and possibly 60% on Chinese imports and even 100% on Chinese EVs imported from Mexico. Simulations with the NiGEM macroeconometric model indicate that this would lead to a rebound in inflation and a slowdown in growth caused by eroded purchasing power and retaliatory tariffs by trading partners.

When it comes to domestic and fiscal policy, the Republicans can cut taxes and deregulate and raise defense spending – assuming that they keep their majority in the House of Representatives. This would boost economic growth, but also add to inflationary pressures. What’s more, the revenues from increased import tariffs are probably insufficient to offset the tax cuts and hikes in defense spending, and so the budget deficit is likely to increase. This could create additional upward pressure on the yield curve, especially at the longer end.

The Fed started the current cutting cycle in September with an outsized 50 bps cut and decided to follow up with an additional 25 bps cut on Thursday. As Powell said at yesterday’s post-meeting press conference, in the near-term the election has no impact on monetary policy. This supports our pre-election expectation of another 25 bps cut in December and a 25 bps cut in January 2025. However, when the Republicans take control of the White House and Capitol Hill, we are going to see a whole different ballgame. A universal tariff of 10% to 20% on all imported goods and even higher tariffs on Chinese goods will likely lead to a rebound in inflation that will stop the Fed’s cutting cycle in its tracks. Big tax cuts and deregulation by Congress will offset some of the negative impact on GDP growth from the tariffs, but they will only amplify the upward impact on inflation. Keep in mind that unemployment is still relatively low and, especially with increased border security, it would not take long for wage pressures to creep back up. This only reinforces our long held call that the Fed’s cutting cycle will be cut short in 2025.

Moreover, the Fed faces more than just monetary policy next year. Trump is not a big fan of the institution nor its chairman, to put it mildly, and with a Republican majority in the Senate, he will likely try to get some grip on the central bank. We discussed this possibility earlier this year in Trumping the Fed, to which we refer for a more detailed analysis. This could complicate the Fed’s monetary policy, as Trump likes low rates and may not approve of the Fed pausing its cutting cycle. Of course, the Fed does not need his approval, because the central bank has a dual mandate from Congress, but it will increase Trump’s incentive to challenge the Fed’s independence. If Trump were to succeed in subjugating the Fed, he could force them to cut rates despite heightened inflation. This would only cause more inflation, so we could see a much steeper yield curve with the short end pinned down by Trump and the long end going ballistic. This is not our baseline. Nevertheless, it remains a tail risk that deserves attention. After all, even the threat to the Fed’s independence could already move markets and cause some steepening of the yield curve as the markets price in a nonzero probability of this extreme event occurring.

In the next two years, we will likely see a major shift in US economic policy. Trump 2.0 seems better prepared, free from the restraints imposed by the former Republican establishment, and supported by a stronger MAGA representation in Congress. The usual Republican policies of tax cuts, deregulation, and high defense spending will be mixed with Trump’s love of tariffs. US institutions are likely to be tested and the Fed will be in the frontline.