The US economy continues to outperform its peers

Besides a further lowering of rates and some long-term policies to reduce the budget deficit, it seems that policymakers should not tinker too much. But try telling that to President-elect Trump. The US economy remains robust and continues to outperform its peers. That’s unlikely to change in 2025.

We see next year’s growth being about the same as this year, at around 2.5%. If there is one key to the US’s performance, it is the robustness of household finances. Aids, such as tax cuts, full employment, strong wage growth and appreciating asset prices, have meant that household net worth has continued to climb steadily. But this masks many factors, such as the significant inequality embedded in the rise in net worth, or the fact that it is mirrored by surging public sector debt. Federal debt now stands at around USD35tn, or about the same size as GDP.

Some projections suggest that the incoming Trump administration could add another USD7.5bn, or more, over the next decade – a rise of around 20%. This would seem to suggest that, if there is any chance of a nosedive in growth, or even a recession, it is most likely to come from the so-called ‘bond vigilantes’ who decide that the government is simply borrowing too much money. But is it likely that the bond market bites back?

The incoming Trump administration certainly looks as if it will give the bond market some ammunition. This includes mass deportations, which could lift labour costs and inflation. It also includes extending the 2017 personal tax cuts and cutting corporate taxes again. These could overheat the economy, produce more inflation, and so lift yields. And then, there are tariffs that also threaten higher inflation, while the revenue gained by the government is very questionable as consumers and firms may slash their purchase of imports. In spite of these concerns, many analysts doubt that the bond vigilantes will have a field day. For a start, the Fed is likely to persist with its easing cycle, and lower policy rates usually mean lower bond yields.

The second issue is that the US’s special status as global hegemon, holder of the world’s most liquid bond market, and issuer of the foremost international currency, imply that the debt levels that the US can rack up are much greater than international comparisons might suggest. It is true that the Trump administration may reduce the pool of foreign savings that are likely to be allocated to the treasury market, by imposing new tariffs on China, for instance. But this pool has been reduced quite a bit already given prior tariffs and other actions, such as sanctions against Russia, and yet the bond market has not melted.

In short, we’ve heard the argument that Trump could face his own ‘Liz Truss’ moment, which is named after the former UK PM whose reckless budget polices unleashed the bond vigilantes on the gilt market back in 2022. “We don’t buy this argument, so, while we think 10-year treasury yields could squeeze up into a 4.5%-5% range in the near term as Trump starts to spell out his policies, the prospect of the Fed taking rates down to the 3.5% region next year should act as a counterweight and so produce a 10-year yield that’s just under 4% by the end of 2025”, said Steve Barrow, Head of Standard Bank G10 Strategy.

In theory, at least, the prospect of tariffs and other measures, that could lift inflation and stymie Fed easing, should lift the US dollar. That’s the reaction that we’ve seen since the election. But one thing to bear in mind is that Trump’s first term between 2017 and 2021 had the same sorts of policies: steep corporate tax cuts, plans for a wall across the Mexican border, and the start of a trade war with China. This period even had the Fed hiking rates in 2017 and 2018 when just about nobody else was, and then a pandemic in 2020 and 2021 that should have lifted the dollar given its safeasset qualities. But, despite this, Trump left the US dollar lower than where he found it. Will things be different in the next four years?

“We don’t see why. So, while we have little doubt that Trump-related dollar euphoria will continue, for now, and possibly through the inauguration next January, the longer-term prospects are not necessarily bright, especially if domestic debt – and external debt – continues to surge”, said Steve Barrow.