What if Donald Trump wins again?

>> What will happen to the US dollar if Trump wins again?

Financial markets seem to be in good spirits. Stock markets are sitting around record highs. Government bond markets are being helped by the first stages of policy easing. Corporate credit spreads and emerging market bond spreads are narrow. The US dollar is broadly stable, particularly against G10 currencies, with little sign yet that it is crimping the room for other central banks to ease policy. But all this ignores the elephant in the room; the possibility of a second term for former president Donald Trump.

Everything that former president Trump seems to be promoting for a second term looks inflationary. If this proves correct, US interest rates seem likely to rise, not fall, and the US dollar will likely appreciate into the bargain, putting a big squeeze on other economies, particularly those in emerging markets. But if higher rates and a higher US dollar are the consequences of Trump’s macroeconomic decisions, the former president will likely try to make lower rates and a lower US dollar the focus of his political pressure. This sets the US on a big internal collision course and, as often happens, when the US sneezes, it is the rest of the world that catches a cold. So, what are these “inflationary” policies that Trump will likely pursue? We’d list three.

The first is on the fiscal front, as Trump’s wish to make the 2017 tax cut permanent risks making fiscal policy too loose, and forcing the Fed to counterbalance with higher rates. Even before factoring in this tax cut, the IMF notes that the primary (non-interest) budget deficit in the US will be in the region of 3% of GDP over much of the next five years. That compares with a balance of close to zero for other advanced countries.

In short, the US starts off from a position of seemingly excessive fiscal largesse, but it could get so much worse under a Trump presidency. While many countries experience pre-election fiscal easing, as governments try to ‘buy’ votes, followed by fiscal consolidation after the election, the US sees the opposite. Congress becomes politically hamstrung before the election and afterwards, new presidents can often experience a ‘honeymoon’ period when they can push through fiscal action – just as Trump did with the corporate tax cut after his 2016 election win.

The second inflationary factor is immigration policy. Trump’s pledge to target 15-20 million undocumented migrants for deportation might turn out to be wishful thinking, but the lesson of Trump’s first term is that there were few empty promises. The problem is that high immigration levels (some 3.3mn were thought to enter the US last year against original estimates of 1mn from the CBO) have probably enabled both robust growth and falling inflation because wage growth has been contained. If Trump turns the clock back on immigration, it could lift wage growth, inflation, and the prospect of higher rates from the Fed.

>> How the US presidential election impacts the US dollar

A third issue that threatens to lift inflation is tariffs. Of course, President Biden is using tariffs as well, but his actions are directed at certain sectors, such as electric vehicle imports from China, not the across-the-board 10% tariff Trump talks about (and not forgetting the 60% tariff floated with respect to China). Again, none of this might materialise but, as we said before, Trump can usually be trusted to at least try to deliver what he promises, as he has done in the past on trade.

In sum, we can see three ways here that inflation could rise materially, and while a new term for Trump would likely see more deregulation, which could help lower prices, we suspect that this will not act as a perfect counterweight. If Trump’s economic policies push up rates and the US dollar, his political priority could be to counterbalance this by impinging on Fed independence and acting to weaken the dollar. But clashes between economics and politics do not tend to have happy endings.

So, will policymakers at the Fed, and investors at large position themselves for the elephant in the room? How can they? Nobody knows if Trump will win. The Fed can’t act presumptively, and investors won’t price in a Trump win. Instead, substantial volatility seems set to ensue after the election result is announced – presuming it is not challenged.