If Trump wins again, how will the Fed respond?

While we think the market will take out a number of anticipated Fed rate cuts from its pricing of future Fed policy, the Fed will likely press on with easing and resist any early pressure for a policy pause. But what about central banks outside of the US? Will they alter their thinking on policy easing and, more to the point, will market pricing change to anticipate either slower or faster rate cuts as a result of a second term for Trump? Steve Barrow, Head of Standard Bank G10 Strategy, thinks there’s a good chance that a Trump win would widen the spread between US and overseas policy expectations.

Steve Barrow said the olicy rate expectations between the US and other countries would be too close together whatever happens in the US election. In short, the market seems to be overestimating how much the Fed will ease and underestimating how much others, like the ECB and BoE, will ease. Market pricing suggests that the Fed, ECB and BoE will all trim policy rates by around 135-bps between now and next September. He does not think that the economics supports such a close relationship, and if we throw a Trump election win into the mix, then market pricing looks even more questionable. We argued that the market could take out up to 50-bps of implied Fed easing if Trump wins on November 5^th; especially if the Republicans take Congress as well. But does this imply that a 50-bps gap will open up between Fed expectations and those of other central banks?

There are two ways to look at this. The first is that expectations for Fed policy exert a natural draw on expectations elsewhere, and perhaps particularly in emerging markets. In other words, if the market thinks that the Fed will cut by less in the event of a Trump win, they will assume the same for central banks elsewhere.

However, there is an alternative view, which is that Trump’s policies do not just increase the chances of a Fed go-slow on rate cuts but actually increase the prospect of faster easing elsewhere on the basis that policies such as higher tariffs will damage growth elsewhere, bring lower inflation (unlike the higher inflation the market would expect in the US) and so force central banks to cut faster. Much could depend on the US dollar.

For instance, if the US dollar rises significantly, it could conceivably make those central banks that are sensitive to currency movements, such as many of those in emerging markets, more likely to follow any Fed rate-cut caution than central banks in the likes of the UK and US, where currency weakness against the US dollar is unlikely to have any policy bearing (unless the dollar’s rise is very dramatic, which we doubt).

In general, Steve Barrow’s view is that any US dollar strength that spins out of a Trump victory in November won’t be sufficient to materially impinge on monetary policy elsewhere, and that is partly down to the fact that the Fed should continue to ease policy. But, in terms of market pricing, we are acutely aware of the magnetic pull of US rate expectations, and that could mean that the market prices in fewer cuts from the likes of the ECB and BoE.

These markets will move as much as the US. So, if US markets price out up to 50-bps of Fed rate cuts over the next year, or so, we doubt that expectations for the euro zone and the UK will move as much. In short, the differential between the US and Europe should still widen. That’s in terms of market pricing, but what will central banks actually do over the coming year, or more, should Trump win? Will they ease by less than they might otherwise, as the market may price in? Or will they actually cut by more than they might have otherwise because of the impact of Trump’s policies?

Steve Barrow suspected that it would be the latter. In other words, his sense is that a return for Trump is more likely to be a negative influence on global economic prospects and more likely to aid the fall in inflation. This being said, he does not believe that central banks will adopt a more dovish policy immediately on a victory for Trump, or even on his inauguration, should he win, but, in time, and despite early market pricing, we see non-US central banks easing by more, not less, should Trump win a second term.