Until relatively recently, political risk – the notion that an election’s result might have a meaningful impact on asset market returns – was not really something those investing in American markets were especially concerned with. Few investors really believed that, say, the outcome of 1996’s Clinton-Dole race would have a lasting impact on the value of the S&P 500. Even 2012’s Obama-Romney contest was given less space in Wall Street research than second-guessing the next steps of the Federal Reserve. In general investors in American markets, like those in many other advanced economies, typically paid more attention to central bankers than politicians. Things are rather different now.
Over the past few months, Wall Street types have taken to discussing the so-called “Trump Trade” which, so far, at least has mostly paid off. Broadly put, the idea has been that a second term for Donald Trump would be great news for American equities, bad but not necessarily terrible for bonds, and positive for the dollar. The logic being that a combination of corporate tax cuts and deregulation will juice stock market returns whilst also sending the government’s deficit up and putting pressure on Treasury yields. Higher American yields should give the dollar a boost. Implicit in all of this is a belief that whilst interest rates would be higher under Trump than Harris, they would not reach a level that would dampen economic growth to an extent that would derail the domestic economy and crimp equity market returns. Trump’s threatened rise in US tariff levels should give the dollar another immediate boost.
The immediate reaction of the markets to the news that Trump had won was a spike in yields, a jump in equities, and further strengthening of the dollar. But whilst markets might be in a celebratory mood about the expected policy-mix of a new Trump administration, many economists have their doubts.
The two major economic policy areas with large macroeconomic implications where Trump is likely to differ sharply from Harris, and indeed the current administration, sit at the heart of the Trump Trade – taxes and tariffs.
The Clark Center’s US Expert Panel was asked about corporate tax cuts and specifically whether allowing the 2017 cuts – carried out by the first Trump administration – to expire back in July. The vast majority of respondents believed that renewing the cuts would materially increase US deficits and Federal debt levels over the coming decade. What is more; more than half of respondents (weighted by confidence) did not believe that extending the cuts would measurably improve American economic performance over the same period. On taxes, the consensus view of the experts is very much a thumbs down.
The US Expert Panel weighed in on tariffs back in April, looking specifically at the impact of higher trade frictions on steel and aluminum. Whilst the panelists believed, with a high degree of uncertainty, that such tariffs might boost domestic employment there was a greater consensus that they would lead to measurably higher finished goods prices for US consumers. More than 70% of respondents, again weighted by confidence, reckoned that the costs of such a policy would outweigh the benefits for the American economy as a whole. More recently, in September, the Panel strongly backed the idea that the costs of higher tariffs would ultimately be borne by consumers in the country imposing them.
The consensus view of economists then, despite the short-term euphoria amongst investors, is far less positive on the agenda of the incoming administration. Much, of course, will depend on how the new White House actually performs in office and what areas it chooses to prioritize. The transition from an electoral platform to a governing policy agenda is, after all, rarely exact.
But there is little doubt that higher tariffs will mean higher US inflation and every prospect that large-scale corporate tax cuts will do little to boost economic growth in the medium term whilst notably increasing borrowing levels. Taken together, more stubbornly entrenched inflation and a higher supply of US Treasuries are likely to push interest rates higher. At their meeting this week the Federal Reserve tweaked the language of its policy communications, dropping the words that it had “greater confidence” that inflation would return to a sustainable 2%. A crackdown on illegal migration could also well lead to higher wage pressures.
A fiscal boost and perhaps higher animal spirits amongst investors could well boost growth in the immediate term but higher price pressures and higher rates are not conducive to faster growth in the medium to longer term.
Meanwhile, outside of the United States, the prospect of higher rates, a stronger dollar, and rising tariff levels is almost unambiguously negative. Goldman Sachs has already sharply revised down their 2025 growth forecasts for a whole raft of European economies.
Political risk is something investors in rich countries are going to have to get used to.
