The New Trump Trades

Summary

• President Donald Trump aims to reverse the decline in the income share of lower income Americans.
• If successful, this could create a macro regime change with higher growth and inflation as well as a steeper Phillips curve:
• The market consequences of the macro regime change include:
  • Higher real yields.
  • Ending US equity markets outperformance.
  • Weaker USD through greater international diversification of US portfolio holdings.
  • Lower bond equity correlation, possibly turning positive.
  • Factor and sector rotation. For instance, ending growth outperformance or further outperformance of smaller banks relative to larger ones.
• Yet implementation risks are substantial.

Market Implications

• I still expect no cut in 2025 against markets pricing about 2.3 cuts.

Main Street Time

The Trump administration’s first few weeks have been challenging for investors. Equity markets have lost all their post-election gains amid multiple and inconsistent policy announcements. Here, I attempt to provide a framework to interpret the administration’s many policy initiatives.

I think Trump’s overarching objective is to solidify and extend the move of blue-collar Americans to the Republican party by raising their real income (Chart 1). If successful, such a move could have deep macro and market consequences. However, this entails substantial implementation risks.

Since the 1970s, low wages have barely increased in real terms while average real wages have risen 70% (Chart 2). But even average wages have increased by much less than productivity and employees’ share of national income has been on a multi-decades’ downtrend (Chart 3).

Secretary Scott Bessent wants to address this issue when stating, ‘It is Main Street time, Wall Street will do well enough but perhaps not as well as in the past’ and that the administration is focused on small businesses and consumers rather than on financial markets performance.

But the administration’s strategy to raise lower income Americans is a break with the past: it aims to improve their labour market outcomes rather than tax and redistribute income (Chart 4).

Multi-pronged Approach to Lifting Low Income Americans

The administration’s strategy to raise real incomes is five pronged.

1. Lower competition from low skill migrants. The administration has effectively closed the border and started large-scale deportations of undocumented migrants. These are reducing competition from low-skilled migrants and could lift the wages of low-skilled Americans. The negative impact of low skill immigration on the wages of low skill Americans has been documented in academic studies (Chart 5). The low wage premium has turned negative following the 2022-25 immigration surge.
2. Higher tariffs and foreign investment policies. Through higher tariffs, and some government fiat, the administration could weaken the incentive for US businesses to move abroad and increase the incentive of foreign manufacturers to move to the US, thus adding to demand for workers (though the manufacturing sector is unlikely to supply many jobs).
3. Strong competition policy. The one policy continuity between the Biden and Trump administrations is the continued revival of antitrust. This is though personnel appointment and continued legal and regulatory enforcement. Also, the incoming team has committed to ‘surgical’ actions and to not impose new regulatory burdens. Continued anti-trust policies could reverse the decades-long trend of rising profit share, the mirror image of the declining workers share (Chart 6).
4. Pro-labour policies. The Republican Party (at least part of it) is turning pro-labour. President Trump has been currying favour with private sector unions and appointed a pro-union Labor Secretary, Lori Chavez-DeRemer, who is likely to be confirmed with bi-partisan support. GOP Senator Josh Hawley has just introduced a union-backed bill that would strengthen unions’ bargaining power. Other presidential appointments have been less pro-union possibly because Trump is still looking for a middle way between his business and populist instincts. Nevertheless, the GOP’s pro-union shift is real and could support a turnaround in unionization (Chart 7).
5. Lower energy prices. Higher wages and tariffs carry inflation risks. Lower energy prices would help keep inflation expectations anchored and support non-energy Wall Street to ‘do well enough’ (Chart 8). The administration’s various diplomatic initiatives are likely to unlock additional energy supplies, as shown for instance by the recent OPEC+ decision to raise output. Since 15 January, WTI prices are down 17% and could fall further.

Of these, I argue the most powerful intervention is immigration. As Professor George Borjas explains, ’because a disproportionate percentage of immigrants have few skills, it is low-skilled American workers, including many blacks and Hispanics, who have suffered most from this wage dip. The monetary loss is sizable. The typical high school dropout earns about $25,000 annually. According to census data, immigrants admitted in the past two decades lacking a high school diploma have increased the size of the low-skilled workforce by roughly 25 percent. As a result, the earnings of this particularly vulnerable group dropped by between $800 and $1,500 each year.’

And this was in 2016, before the recent immigration surge.

Higher Trend Growth

In think trend growth under Trumponomics would be higher for four reasons:

1. The paradox of thrift in reverse. Someone’s spending is somebody else’s income, but spending and producing decisions cannot be coordinated in a market economy. Hence Keynes’ paradox of thrift: if all economic agents independently plan to save more, they collectively end up consuming and producing less and possibly with lower actual savings. Shifting the distribution of income towards lower income Americans, who have a lower propensity to save, would lower the planned savings rate and raise overall growth.
2. Greater competition would increase business innovation and productivity. The antitrust movement’s growth in the past few years, which is increasingly grass root rather than only government-driven, reflects strong evidence that the high concentration of the US economy has stifled innovation, new business formation and ultimately productivity and growth.
3. A monopolistic economy tends to have lower production levels because profits decrease with production. Firms would rather employ fewer workers to maximize profits. This can seen through bargaining agreements that typically commit employers to staffing levels and wages. Therefore, a more competitive economy could see businesses expand faster.
4. A more efficient allocation of capital. Over the past three decades, global central banks have been chasing structurally low inflation, resulting in low real interest rates, which weakened the allocative efficiency of capital markets and caused recurrent financial crises. For instance, central banks’ bond purchases have raised the returns on financial investment relative to business ones and therefore weakened the latter. Higher incipient inflation would force central banks to maintain higher real rates and reverse this process.

Despite the 1990s IT revolution, the US economy moved to a lower growth path during the 2000-10s that could well reflect the factors listed above (Chart 9). In addition, IT was a labour augmenting technical innovation and thus contributed to workers loss of bargaining power and lower income share. With Trumponomics and a credible central bank, the US economy could move to a higher growth path with stable if somewhat higher inflation.

Higher Inflation, Steeper Phillips Curve

Trumponomics success would likely bring about higher inflation and long-term unemployment, as well as a steeper Philipps curve. Higher inflation would reflect greater worker bargaining power and more of a conflict over income distribution. This ‘conflict theory of inflation’ has existed since the 1970s and is expressed by prominent economists such as James Tobin. It aligns well with the disinflation and loss of union power of the past 40 years (Charts 7 and 9).

By ‘higher inflation’, I mean inflation possibly higher but still near the Fed 2% target, and stable, which could be achieved through central bank credibility. This compares with inflation undershooting the Fed target in the three decades before the pandemic.

Also, a post Trumponomics economy could carry a higher long-term unemployment rate. This is because greater business formation and innovation could entail higher labour market churn. In addition, with lower profitability per workers, firms’ incentive to search for additional workers is lower. This is shown in whether the decrease in the long-term unemployment rate (NAIRU) was accompanied by an increase in profits per workers and a decrease in the ratio of actual hires relative to job openings (Chart 10)

But higher inflation and unemployment would not imply lower wellbeing. Rather they would reflect a more dynamic economy.

Lastly, stronger worker bargaining power could see a steeper Phillips curve, as stressed in a recent Fed paper. The intuition is that with weak market power, workers are unable to obtain much higher wages when the economy is hit with a positive demand shock. Instead, because hiring extra workers is so profitable, employers react by expanding employment. As a result, smaller changes in inflation are associated with larger changes in employment. These dynamics would work in reverse with stronger worker bargaining power.

Successful Trumponomics would have deep market implications

New Trump Trades

A market regime change would accompany a macro regime change. Real yields could rise further (Chart 11). Yields tend to track GDP growth with the spread between yields and GDP growth as a form of ‘macro risk premium’. In the low volatility environment of the 2000s and 2010s, yields have been below GDP. With higher inflation and a generally more volatile macro backdrop, real yields could climb above real GDP growth, aligning with the experience of the 1980s and 1990s (yields below GDP growth in the 1960s and 1970s reflected financial repression).

The combination of a declining profit share of income and higher real yields could see the ratio of equity market capitalization to GDP stabilize and even fall (Chart 12). As Bessent predicted, Wall Street would do well enough but perhaps not as well as in the past. This could end US equity outperformance (Chart 13).

With the end of US equity outperformance, US investors could seek greater international diversification of their portfolios and foreign investors could reduce their holdings of US equities. As a result, the equity balance could turn negative, supporting a weaker dollar (Charts 14 and 15).

Also, the negative bond-stock correlation could weaken or even turn positive (Chart 16). This is because bond and stocks negatively correlate with inflation, while stocks are correlated positively with growth but bonds negatively. In addition, the economy would be moving from a regime dominated by growth shocks to a regime dominated by inflation shocks.

Meanwhile, there could be factors and sector rotations. For instance, the growth stocks outperformance could end, and the outperformance of smaller banks relative to large ones, that tend to be more capital markets focused, could increase further.

Large Implementation Risks

Trumponomics has substantial upside, political and economic, but entails substantial implementation risks.

For instance, supporting stronger wage gains risks igniting a wage-price feedback loop. Managing these risks requires strong competition policy and a strong, independent central bank. Lower energy prices would mitigate these risks by engineering real wage growth with constant nominal wages.

Deportations of illegal migrants could shrink the workforce, depress consumption and trigger stagflation if migrants do not work out of fear of deportation.

Maintaining a ‘good enough’ equity market performance while shrinking profit income share would require a strong growth rate. Lower energy prices would also help maintain profits and equity performance outside of the energy sector.

Tariffs increases would need to be implemented in a predictable and gradual manner. This would minimize the unavoidable short-term costs associated with higher import prices (necessary to shift business investment) while increasing the risk of long-term gains.

Finally, there could be conflicts with the administration’s other goals. For instance, fiscal consolidation that in the short term could depress demand.

Market Consequences

Following the administration’s multiple and inconsistent policy announcements, consumer and business confidence have fallen, and markets are now pricing 2.5 cuts by December, with a full cut at the June FOMC meeting.

I do not share this pessimism as the foundations of the expansion are solid and I expect the administration to correct course and strive for clearer messaging and pro-growth policies.

Even if I am wrong on the administration’s policies, I see them as having more of a detrimental impact on supply than on demand. This suggests the risks to inflation remain skewed to the upside. Therefore, I still expect no 2025 cuts, though my conviction is lower than a month ago.

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