The American people have spoken. While not all votes have been counted, Donald Trump has already secured enough to declare himself the new president. The Republicans have also gained a majority in the Senate and still have a chance of controlling the House of Representatives. Such a “red sweep” would enable Trump to implement much of his agenda. On the day after, November 6, Charles Kalshoven (Expert Strategist at APG) and Maarten Lafeber (Senior Strategist at APG) discussed market reactions and potential implications for the coming years.
Published on:
7 November 2024
In a nutshell
• Trump’s economic agenda centers on tax cuts and deregulation, particularly in fossil energy.
• The combination of higher inflation expectations and cheaper oil is unusual, as they typically move in tandem.
• Trump's economic plans point toward higher inflation in the U.S., with potential short-term offsetting effects, though these are unlikely to be sustained over the long term.
What’s happened?
The U.S. elections have a clear winner: Donald Trump. Fortunately, we are spared a lengthy legal battle over alleged election fraud. Polls had shown the candidates running neck-and-neck, but this close margin didn’t necessarily translate into the Electoral College, as polling error margins are considerable and positively correlated. We now know that all swing states have tipped in Trump’s favor.
A third of the Senate seats were also up for election, primarily Democratic seats. By reclaiming several seats, Republicans now hold a Senate majority. At the time of writing, it is still unclear whether Republicans will retain control of the House. However, it is evident that Democrats lack the upper hand. Their plans for tax hikes and stricter regulation are now off the table. With a majority in the House, Democrats could still obstruct or dilute Trump’s proposals.
What does Trump want?
Trump’s economic agenda centers on tax cuts and deregulation, particularly in fossil energy. Domestically, he has expressed an interest in imposing a universal 10% tariff on imports and potentially raising tariffs on Chinese goods to as much as 60%. Additionally, he intends to limit immigration and reverse past illegal immigration through mass deportations.
Trump also appears willing to challenge established institutions. His inner circle has speculated about possible political intervention in the Federal Reserve. International institutions might also be tested, including the World Trade Organization (WTO) and military alliances like NATO. U.S. support for Israel could increase, while it may diminish for Ukraine and Taiwan.
How are markets reacting?
Initial responses from stock markets, both in the U.S. and Europe, were positive, mirroring the “Trump trade” previously seen. U.S. futures indicated a higher open, with the S&P 500 up 2.2% and the Nasdaq up 1.6%. This positive opening indeed led to sustained gains throughout the trading day. The Euro Stoxx 50 was up 0.4% initially, but by the end of the day, it had recorded a loss of approximately 1.5%. Bond markets, on the other hand, experienced a sell-off, with the U.S. The U.S. 10-year yield rose by approximately 20 basis points, driven by both an increase in the real interest rate and higher inflation expectations. Oil prices dropped by 2.2% (“Drill, baby, drill”). The combination of higher inflation expectations and cheaper oil is unusual, as they typically move in tandem. Additionally, the U.S. dollar strengthened against the euro and the Japanese yen, by 2.1% and 1.7%, respectively. On November 7, however, part of these gains was reversed against both the euro and the yen.
Under the bonnet, equity market reactions have been mixed. For instance, the European auto sector took a hit due to potential tariffs, with German automakers such as BMW, Mercedes, and Volkswagen opening 4-6% lower, while Tesla, which is also listed in Frankfurt, rose by 15%. These levels have largely held steady up to now. American banks performed well in anticipation of sector deregulation.
The strengthening of the dollar is likely linked to rising interest rates. However, the proposed tariffs could also be contributing, as they might reduce global dollar supply by limiting demand for imports. Expectations for the Fed funds rate by the end of 2025 have only slightly increased. Markets may be counting on the Fed to set its own course for now, with limited impact from a looser fiscal policy on next year’s inflation. Alternatively, investors might expect some inflationary impact but believe the Fed will be reluctant to react with a tighter policy. Breakeven inflation has increased by about 10 basis points, suggesting the truth is somewhere in between.
Undermining the Fed’s independence could cause major turbulence
What does this mean for the economy?
The initial market reaction is positive for risk assets, which makes sense. Government finances are expected to deteriorate, driving up interest rates, while corporate earnings are likely to improve thanks to expected tax cuts, supporting stock prices. But what are the longer-term implications of Trump’s presidency for the economy and financial markets? Deregulation—particularly for oil and banks—could provide a growth boost. The threat of tariffs might also lead to increased investment in the U.S. at the expense of investment elsewhere.
However, questions remain as to whether this will sustainably strengthen the supply side of the economy. Mass deportations of immigrants, if they occur, could significantly tighten the labor market, making the actual investments more challenging. Tariff walls disrupt production at its most efficient locations and reduce the ability to absorb economic shocks. All of this points toward higher inflation in the U.S. There may be offsetting effects in the short run – a stronger dollar, price reductions by foreign exporters, importers’ willingness to lower margins – but not structurally.
Tariff barriers are also unfavorable for the global economy. In some cases, investments might shift to the U.S., while in other cases they may not occur at all due to rising uncertainty, which could hinder economic growth. The inflationary impact remains uncertain. Supply-side shocks tend to lead to stagflation but demand shocks may dominate. A historical parallel is the 1930s, when escalating tariffs worsened the Great Depression, leading to deflation rather than inflation.
Long-Term Implications
In the longer term, the impact of Trump’s leadership on both national and international institutions will be significant. Undermining the Fed’s independence could cause major turbulence, though this very risk makes such a move unlikely. Other international agreements and institutions may be less sacrosanct. Under Trump, the U.S. previously set aside the Paris Climate Agreement, potentially hindering energy transition ambitions globally. Trump’s interest in making trade deals could lead to conflicts with the WTO. Trade tensions with China—and possibly with Europe—could also escalate. Regarding security, it remains to be seen how committed the new U.S. administration will be to NATO allies and other partners. The future is more uncertain for Ukraine and Taiwan, while Israel may enjoy stronger support.
Overall, the world has become less predictable, a shift that generally justifies higher risk premiums rather than lower ones. The positive response of risk assets is likely driven by anticipated tax cuts, with rising interest rates following suit. While it is too early to translate these changes into expected returns, the increased unpredictability underscores the growing importance of scenario analysis.