Tariff concerns, growth prospects and the long-term outlook for a Trumpian America

Natixis IM Solutions’ Mabrouk Chetouane sits down with Tom Fahey, co-head of the Loomis Sayles Macro Strategies team to look at the long-term implications of Trump’s election for US and global markets.

Mabrouk Chetouane:  The re-election of Donald Trump as US president is arguably the key event of 2024, with significant implications for growth, inflation, fiscal policy, and monetary policy. With Republicans also winning control both chambers of Congress, the election results give Trump a strong mandate in his second term. What does this strong mandate mean for Trump's fiscal policy plans?

Tom Fahey: The strong mandate suggests that Trump's fiscal policy proposals can proceed, but US politics tend to be evolutionary, not revolutionary. Even with a slim majority, some Republicans may oppose more contentious proposals. For example, Trump has significant leeway in imposing bilateral tariffs without congressional approval, as they are considered foreign policy. However, a universal tariff would be challenging because it requires congressional approval, and many free traders in the Republican party might oppose it. Similarly, cutting the corporate tax rate to 15% is unlikely to pass Congress due to its potential to significantly increase US debt.

. Trump's proposed policies involve a lot of red ink, with increased defence spending and extended tax cuts leading to large deficits. The revenue from tariffs may not be sufficient to offset these deficits. Under the first Trump administration, the Tax Cut and Jobs Act (TCJA) reduced the corporate tax rate from 28% to 21% and cut individual taxes. These taxes expire at the end of 2025. Trump's proposal is to extend these cuts and add individual cuts in areas like overtime and social security. While some one-off giveaways might happen, cutting the corporate tax rate to 15% seems excessive given the budget impact. So, to some degree, the main policy is extending the TCJA.

Mabrouk: So, if the TCJA is not extended past 2025, the US deficit could decline due to higher tax revenues. But if extended, the deficit will remain around 6% of GDP. It wouldn't be a significant fiscal stimulus, just an extension of the current situation. Can this situation last?

TF: Exactly. It's not an additional fiscal stimulus. Budget deficits will stay around 6-6.5% of GDP. The key question is what else gets included in the policy and how they account for any giveaways. If tariffs don’t generate enough revenue and all proposals are enacted, the deficit could reach 9% of GDP, which would be very stimulative, especially at full employment. It is important to note that initial policy proposals from the new administration show two thirds of Trump’s fiscal revenue gains come from tariffs. That is a shaky revenue source.

MB: Is that sustainable, even for the US economy, especially when countries financing the US deficit might start financing their own?

TF: Budget constraints in the US seem to have relaxed significantly. Both parties seem unconcerned about debt levels. The dollar remains the world’s reserve currency, and while debt is a level, GDP is a flow, so it's not a like-for-like comparison. US debt-to-wealth ratios are more favourable. Treasuries remain valuable collateral, and the attractiveness of US fixed income is strong. The key question is whether fiscal policies will generate excessive demand relative to supply, potentially leading to inflation. Immigration policy might also impact this balance. On top of that, inflation is returning to desired levels, with Fed interest rates possibly settling between 3-3.75% and inflation around 2%.

MB: I think you are right. To take that point further, you say the US is close to a kind of equilibrium and the Fed’s ambition is to make sure that the monetary policy is aligned with this equilibrium, but you also mentioned immigration policy, which is clearly a key issue. How likely do you think it is that Trump will enact his immigration plans and, if he does so, are you worried that the resulting negative shock on growth and the positive shock on inflation would create a stagflationary environment?

TF: The proposed policies could reduce labour supply and lead to inflationary pressures. Tariffs act as a tax on consumption, raising prices for imported goods. The combination of reduced labour supply and increased prices could have an impact, but the extent depends on how aggressive the policies are.

MB: It will certainly be another constraint for the Fed to manage. But, if I look at what happened during Trump’s first term, he did adopt something of a gradual approach and didn’t seem to be trying to kill business. Take China, for example, he didn’t implement the 20% tariff immediately. Are you expecting a similarly gradual approach this time?

TF: I expect a more aggressive approach toward China. In the previous term, there was a lengthy investigation process before tariffs were implemented. Now those investigations have been completed, so I wouldn’t be surprised to see tariffs put on China (and possibly other trade partners) quickly. I don’t know when tariffs will come, but I think it is something that will happen in 2025, and it could potentially be within the first 100 days of Trump’s new term.

That said, if you remember when the tariffs were imposed on China the first time, China agreed to meeting import targets as a way of lowering the level of tariffs. Targets they haven’t come close to meeting. So, I do think there is a potential for a very confrontational stance towards China.

The other thing I would add is that, from China’s perspective, in previous years they have recycled their excess savings into the property market. The subsequent property boom resulted in significant imports of iron ore, copper etc. Now that the property market has blown up, a lot of that excess capacity has been pushed into the manufacturing sector. A good example of that is the impact China is having on Germany’s auto sector. If you consider the fact Volkswagen is potentially shut down three German manufacturing plants, you know that excess capacity is a big global problem. There is a legitimate desire from the rest of the world to try to limit China’s ability to dump excess capacity onto global markets, and it is something we will come head-to-head with in the next couple of years.

MB: How do you think markets will react to Trump's victory in the medium term?

TF: The US corporate sector looks strong, with earnings growth expectations around 8-13% through 2025. If achieved, that would be very strong. The expectation of reduced regulations, especially in banking, has already boosted small-caps and banks. Healthy banks and a broadening of earnings into the small-cap space could support equity and corporate bond[MT1] [GC2]  markets.[MT3] [GC4]

MB: What's the outlook for interest rates?

TF: We anticipate the Federal Reserve will continue cutting interest rates in December, potentially reaching around 3.5% by the end of 2025. The 10-year US Treasury yield should hover around 4%, providing what we see as a solid yield environment.

MB: How does this affect the dollar?

TF: A lot depends on how stimulative fiscal policy will be. In the early 1980s, high real interest rates, loose fiscal policy, and tight money were positive for the dollar. The bigger question is whether there will be a change in global risk appetite. European equity markets are cheaper than the US, and emerging market interest rates and FX look cheap. If Europe pivots toward loosening budget constraints, it would be nice globally if the dollar could weaken.

MB: I like your optimism, Tom, but I doubt European countries will agree on a common strategy. That said, where do you see the risks?

TF: I always say profits drive the cycle, so what might cause profits to collapse? Trade volatility and uncertainty are big risks. An aggressive trade war could disrupt business confidence. For a healthy global economy, we need China and Europe to grow. Negative shocks from Europe, like lack of growth, could impact the US economy.

MB: Policies like the Inflation Reduction Act (IRA) have helped US growth potential. Is there a chance Trump might end these policies, or are they likely to continue supporting the economy?

TF: The outlook for potential growth is positive. It's a chicken-or-egg situation on the fiscal side. The IRA law opened a larger budget deficit, but it transferred resources to the private sector, boosting investment and potential growth. I'm a Keynesian economist, and I believe in fiscal policy. From a European perspective, I'd like to see budget constraint fears lifted. Fiscal support is needed to transfer resources to the private sector and stimulate demand. If the US continues to outperform, the need for fiscal support will become more apparent, and other countries may follow suit.

MB: The discrepancy between the price-earnings ratios of the European stock market (STOXX 600) and the S&P 500 has widened since Trump's first election. My fear is this will continue due to the US economy's outperformance. Europe struggles to implement comparable policies. The Draghi report suggests €800 billion investment per year is needed, but there's been no reaction. Without investment, we can't generate growth or spend to support it. We are in the opposite situation compared to the US.

TF: The Draghi report is important and should stimulate debate. If the divergence continues, it will become intolerable for voters, and parties might shift toward a more aggressive industrial policy like in the US.

MB: Europe can deliver significant results when pressured. During Covid-19, we mutualized debt to protect economies. In crises, European countries find solutions. The problem is waiting for the next crisis to deliver significant progress.

TF: Europe has shown resilience, but investment capacity is critical for future growth. The challenge is creating an environment conducive to investment, especially considering the Draghi report's call for significant investment.