Trump 2.0: Volatility Ahead?

Summary

• A second Trump administration would likely widen the budget deficit, end immigration, and raise tariffs further.
• Unlike the first Trump administration, a second administration would inherit an economy with strong resource pressures, and these policies could therefore raise inflation.
• As a result, the Federal Reserve (Fed) may have to tighten policy.

Market Implications

• Contrasting the Reagan administration, the combination of loose fiscal and tight monetary policies may not support the dollar or US equities if accompanied by a loss of market confidence in US economic policymaking.

Trump’s Plans Are Ready, Biden’s Yet to Be Revealed

As the Iowa caucus shows, the 2024 presidential election will likely be a Biden-Trump re-run. In this note, I compare the likely economic policies of future Trump and Biden administrations.

In 2016, the Trump campaign was unprepared for a win and the exceedingly complex presidential transition process. However, this time the Trump campaign has created a full-fledged program. The campaign website provides a summary.

In addition, former officials in the first Trump administration have established a think tank, the America First Policy Institute (AFPI), sometimes described as ‘a White House in waiting.’ Senior staffers include Larry Kudlow, former NEC director, Brooke Rollins, former head of the Domestic Policy Council, and Linda MacMahon, former head of the SBA. AFPI has a list of policy proposals that expand on the campaign website and has appointed a chair of the transition project.

Finally, the Heritage Foundation, the premier American conservative think tank, has published a mammoth volume on key policy priorities and their detailed implementation, the Mandate for Leadership. The volume is part of Heritage’s Project 2025, a detailed transition program inspired by the transition program the Foundation prepared for former President Ronald Reagan in 1980. Its authorship reads like a who’s who of US conservative policymaking, but its authors are generally farther from the Trump campaign than the AFPI staffers.

By contrast, President Joe Biden has yet to fully fledge his policy priorities for a second term.  His campaign website displays the slogan ‘FINISH THE JOB’ but no specific policy proposals. With Biden lagging in the polls, prominent Democrats have repeatedly pressed him to outline his plans, but so far he has not.

Campaign officials believe Biden will benefit most from a campaign roll-out in the spring or summer when they expect voters to get more engaged. His State of the Union speech to Congress, scheduled for 7 March, could be an opportunity to unveil his plans since millions of Americans typically watch it. In this note, I will assume continuity with the policies pursued in the first Biden mandate.

Trump 2.0 Would Add to Fiscal Deficit

Table 1 shows the key differences between the Trump and likely Biden programs. Fiscal policy would move in opposite directions in Trump and Biden administrations.

Unsurprisingly, the Trump campaign wants to cut taxes, while the Biden administration has said it wants to raise taxes on wealthier Americans. Both camps want to increase spending, mainly on defence on the Trump side, and mainly on social measures on the Biden side.

Both the AFPI and the Heritage Foundation want to get back to budget balance. On Biden’s side, following Moody’s downgrade of the US sovereign rating outlook last November, Treasury Secretary Janet Yellen declared the administration is ‘completely committed to a credible and sustainable fiscal path.’

In reality, the tax cuts supported by the Trump campaign are likely to see an increase in the fiscal deficit. Since the Trump campaign wants to increase military spending and protect Medicare and Social Security, the main entitlement programs, this leaves mainly non-defence discretionary spending to be cut. But this category accounts for less than 15% of spending, and finding the necessary savings will be hard.

The precedents are not encouraging. In 2017, the Trump administration’s enactment of the Tax and Job Cuts Act saw revenues decline 1ppt of GDP and the deficit increase three quarters of a ppt of GDP (Chart 1). In the 1980s, the Reagan administration’s tax cuts caused a 2ppt of GDP decrease in tax revenues that contributed to a 3.5ppt of GDP increase in the deficit.

Trump 2.0 Would Clamp Down on Immigration

One of the Trump campaign’s core policies is to lower immigration by eliminating illegal immigration, tightening border protection, and moving to a merit-based immigration system. The AFPI adds to these policies with finishing the US-Mexico border wall, while the Heritage Foundation envisages using the army to help secure border protection.

By contrast, the Biden administration has an unclear immigration policy. It initially reversed many of the Trump administration policies, including building a US-Mexico border wall and deportations. But following a surge in illegal immigration, it reintroduced some of the Trump administration’s policies and, for instance, used the army to strengthen border protection.

Two-thirds of the increase in the labour force since 2020 is accounted for by foreign workers (Chart 2). An immigration clampdown like that implemented during the Trump administration could therefore significantly impact labour supply growth and support faster wage growth.

Tariffs

While the Trump campaign does not explicitly discuss tariffs, the AFPI makes it clear that a second Trump administration would maintain tariffs on China and impose tariffs on other countries ‘where appropriate to support American workers.’ By contrast, the Heritage Foundation’s Mandate for Leadership presents two opposite views on trade. One from Peter Navarro, a former Trump administration official, advocates for more protectionism. The other one makes a plea for free trade, which is more in line with establishment conservative views.

The Biden administration’s trade policies are somewhat less protectionist. Under the Biden administration, custom duties have fallen relative to imports, and imports have recovered relative to GDP (Chart 3). The administration has maintained Trump-era tariffs and trade restrictions and tightened restrictions on trade in strategic sectors. Simultaneously, it has sought to resolve trade issues with the European Union.

Industrial and Energy Policies

There is little difference between the Biden administration’s reshoring plan and the Trump campaign’s announced four year reshoring plan. While the AFPI does not discuss the plan, it receives strong billings in the Heritage Foundation transition guide, which sees the disappearance of manufacturing jobs as a core source of perceived American decline. The Foundation therefore makes a strong case for restoring manufacturing jobs and pursuing an activist industrial policy.

Interestingly, both the AFPI and the Heritage Foundation criticise the Inflation Reduction Act, the Biden administration’s main industrial policy tool, which distributes subsidies in preferred sectors. However, it is unclear what a Trump 2.0 alternative would be. Ultimately, industrial policy consists largely of the government giving handouts to its favorite industries (Chart 4).

Finally, a second Trump administration would liberalize energy production and distribution and relax environmental rules, contrasting with the more restrictive policies of the Biden administration.

Market Consequences

It took about two years for the Trump administration to start implementing its policies. By contrast, this time key policies are likely to be implemented shortly after inauguration.

Also, unlike under Trump 1.0, this time the US economy is experiencing strong resource pressures and loose policies, if hidden by falling energy prices (Table 2).

In this context, the policies a Trump 2.0 administration would likely implement would likely reignite inflation. Rising inflation, in turn, would elicit a policy response from the Fed, with rate hikes likely. Hence a second Trump administration could see a combination of loose fiscal policy and tight monetary policy.

The precedent is the Reagan administration in the early 1980s, where the combination of tight monetary and loose fiscal led to dollar and equity strength. This time, though, with government debt above 100% of GDP, compared with 25% of GDP under the Reagan administration, markets could react negatively to a widening of the already very large fiscal deficit.

Furthermore, during his first mandate former president Trump publicly berated the Fed for being too tight. A repeat of such comments could undermine public confidence in the dollar and dollar assets.

By contrast, a second Biden administration would likely see some form of fiscal consolidation, as well as the continuation of current immigration and trade policies. This would be less inflationary and therefore less likely to elicit Fed tightening. These suggest lower market volatility under a second Biden versus a second Trump administration.

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)