11/11/2024

The market got it right. This is the main takeaway from the results of last Tuesday's US presidential elections. Indeed, the market seemed to be betting decisively on a Trump victory, even as the polls predicted an extremely tight presidential race. The polls were once again wrong, and Trump triumphed in the election, winning the seven swing states.

The Republicans also regained control of the Senate, as expected, but the likely victory in the House of Representatives was far from a foregone conclusion. With 18 House seats still to be decided, the Republicans have already secured 214, compared to the 203 projected for the Democrats. The Republican Party needs at least 218 seats, which is now considered a given in Washington. We are, therefore, looking at a "Republican landslide" scenario that few had predicted.

In short, voters have given Trump and his party a solid mandate, requiring the markets to carefully assess the impact of his policies on the economy, not just in the U.S., but globally. Trump's proposals revolve around four key elements: increasing tariffs, deporting illegal immigrants, cutting taxes, and easing regulatory burdens.

If taken literally, his proposals represent a very radical combination of policies. First, his idea of imposing a 60% tariff on China and 10% on all other trade partners would raise the average tariff on imports from 2% to 17%. Secondly, the proposal not only to extend the 2017 tax cuts but also to reduce the corporate tax rate from 21% to 15% would provide a very significant fiscal stimulus. In the regulatory arena, Trump has promised to significantly deregulate energy policy and has said he wants to "drill, drill, and drill" from day one. Finally, Trump wants to deport the twelve million immigrants estimated to be in the country illegally.

What would the effect of these policies be? In terms of tariffs, an increase of this magnitude would have negative effects on economic growth and inflation in both the United States and its trade partners in the medium term. Similarly, a sudden and significant reduction in the labor supply caused by deportations would increase wage pressures, resulting in higher inflation and lower economic growth on the investment side.

On the other hand, deregulation should reduce transaction costs for businesses and could also lower energy prices if there is an increase in oil and gas supply. The tax cut would also have a positive effect on economic activity by incentivizing investment and labor supply. However, and this is important given the complex fiscal situation in the United States, tax cuts could be counterproductive if they increase the deficit. Therefore, the positive effect of a lower corporate tax rate should be assessed in relation to the risk of making the U.S. fiscal trajectory unsustainable, which would lead to significantly higher interest rates. In light of these risks surrounding Trump’s proposals, one might wonder why financial markets reacted so positively. In this regard, one explanation is that the uncertainty related to the electoral outcome has completely disappeared. It was no small risk that the election could have been contested or that the proclamation of the new president could have been delayed for weeks or even months. The results were so clear that this significant risk has evaporated, leading to an immediate drop in the risk premium.

The second reason likely lies in the fact that investors do not believe Trump will implement his policies to the letter. In this regard, the market's assumption seems to be that the new president would simply seek to negotiate favorable trade agreements, without actually intending to impose such a large tariff increase. Investors also trust that the new president will surround himself with a capable and experienced team, which will bring a high level of pragmatism to Trump’s policies.

Only time will tell how true these assumptions are, but it seems reasonable to expect that the policies will not be as radical as initially advocated by the new president, that they will take time to be implemented, and that they could face some resistance, even from a Republican Congress.

In short, it is likely that Trump’s policies, even if watered down, will lead to higher inflation rates and lower economic growth in the medium term, both in the U.S. and around the world. Similarly, it is expected that the Federal Reserve will embark on a slower process of rate cuts and that the dollar will strengthen against other currencies. Certain geographical areas will be especially affected by the tariff threat, particularly China and Europe.