As Biden withdraws, what would a second Trump presidency mean for the US economy?
Trump’s presidential campaign gained momentum after he survived an assassination attempt. A new Democratic challenger could reshape the narrative around the race but Trump remains favourite for a return to the White House, which would have far-reaching implications for the US economy.
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After weeks of speculation, President Biden announced over the weekend that he would withdraw from this year’s presidential race and endorsed Vice President Kamala Harris as the Democratic nominee instead. While her nomination as the official candidate is yet to be confirmed, the cards are stacked in her favour and she appears the likeliest candidate based on betting odds.
Chart 1: Betting odds: Democratic presidential nominee (% probability)
Source: Schroders Economics Group, PredictIt, Macrobond. 22 July 2024
Attention is now turning to Harris’s potential running mate. Governors of battleground and deep red states are among the likeliest candidates. Meanwhile, the odds of the Democrats retaining the White House have improved slightly, not least as Harris has a clean slate to change the narrative around the election.
Chart 2: Bettings odds: winning party in US presidential election (% probability)
Source: Schroders Economics Group, PredictIt, RealClearPolitics, Macrobond. 22 July 2024
In terms of the market reaction, we have seen yield curves steepen over recent weeks as expectations of a Trump victory rose. This was because a Republican “clean sweep” would allow Trump a freer hand on fiscal stimulus. By contrast, a Democratic president would face a divided government. It may therefore be that the recent steepening of yield curves will reverse if Harris, or another Democratic candidate, narrows the gap in the polls.
Nonetheless, Donald Trump still appears to be the likelier winner. The recent assassination attempt has given his campaign considerable momentum that could carry him through to the November election. Given Trump’s lead in the polls, we set out our key economic expectations if there were to be a Trump victory.
Trump’s economic agenda remains firmly neo-mercantilist
If Trump were elected president, his agenda will be partly dictated by how Congress shapes up. In the Senate, the Democrats face a near impossible task of retaining their slim 51-49 majority this year. Two-thirds of the 34 seats being contested are held by the Democratic caucus. Three of these look particularly vulnerable: West Virginia, following Senator Joe Manchin’s decision to not seek re-election, as well as Ohio and Montana, states which Trump carried comfortably in the previous two presidential elections. As a result, the Republicans are well positioned to regain control of the Senate.
However, the House of Representatives is a more open contest. All 435 seats are contested every two years and the Democrats, now in the minority, only need to pick up five additional seats to shift the balance of power. Here, partisan divisions surrounding abortion could prove pivotal, much like they did in the 2022 midterms. But presidential elections tend to have an impact on down-ballot races through a “coat-tail effect”. So, if Trump were to be returned to the White House, he stands a reasonable chance doing so with an ideologically aligned Congress, while also benefitting from the conservative majority in the Supreme Court that he helped appoint.
Chart 3: Senate arithmetic favours the Republicans in 2024
Source: Schroders Economics Group, 270toWin, 22 July 2024.
Still, Trump does not need their support for the central plank of his economic agenda: protectionism. As president, he cited national security concerns to raise tariffs, using the power granted to presidents under Section 232 of the US trade laws. Beijing was the most common target, with the average tariff levied on imports from China climbing from 3% to nearly 20% during his term. If re-elected, Trump has proposed to hike this to 60% as well as phasing out all imports of essential goods from China. In addition to this, imports from the rest of the world would be subjected to a 10% baseline tariff.
If implemented, these proposals would present a significant inflationary shock. However, we suspect Trump does not intend to fully follow through with these but instead leverage them in a targeted manner to extract trade concessions. When he was president, his administration gradually ratcheted up tariffs, starting with industrial goods that would have little direct impact on consumer inflation. It was a relatively unconventional approach but ultimately a successful one as it resulted in the “phase one” deal with China as well as a re-negotiation the North American Free Trade Agreement.
Assuming we are correct and Trump sticks to the same playbook, three factors should help to blunt the inflationary impact of tariffs. Firstly, the dollar would likely appreciate, especially against the renminbi, as Beijing would probably pursue a devaluation. Secondly, the widening in corporate profit margins since the pandemic should serve to absorb higher import costs. Thirdly and finally, goods might be routed via countries that are on more favourable trade terms with the US, as China appears to have done since the start of the trade war.
Chart 4: US-China trade war had little inflationary impact, partly due to re-routing
Note: 11 tariff-impacted CPI categories are laundry equipment, other appliances, furniture and bedding, floor coverings, motor vehicle parts and equipment, sports vehicles (including bicycles), housekeeping supplies, sewing equipment and supplies, home décor, outdoor equipment and supplies, dishes and flatware.
Source: Schroders Economics Group, Bureau of Labor Statistics, Macrobond. 22 July 2024
However, Trump’s immigration plans would be more challenging to circumvent. He has pledged to deport 15 million undocumented individuals and suggested this might be modelled on Eisenhower’s 1954 deportation initiative along the border with Mexico. Whether this is ultimately realised remains to be seen; Trump similarly promised to deport 11 million people during his first term but failed to deliver this. Still, his administration did manage to cut annual net inward migration from 650,000 to 200,000 by enacting some 472 administrative changes.
Another immigration clampdown would likely be more disruptive this time around. Job growth in recent years has been almost entirely driven by foreign-born workers, with the native-born labour force having stagnated. Lower immigration is therefore likely to exacerbate worker scarcity, particularly in sectors heavily reliant on foreign labour such as agriculture and construction. This could then lead to a resurgence in wage growth that further stokes inflationary pressures, especially as the drag on the labour force would also weigh on potential GDP growth.
Chart 5: Immigration clampdown likely to prove the bigger economic challenge
Source: Schroders Economics Group, Bureau of Labor Statistics, Dallas Fed, Customs and Border Protection, Macrobond. 22 July 2024
In isolation, higher inflation and lower job creation would act as a headwind to the economy. But our expectation is that this will be more than offset by various growth promoting policies. Of these, the biggest will be Trump’s promise to extend the provisions from his 2017 Tax Cuts and Jobs Act (TCJA) that are due to expire next year. Also, Trump has said that he would cut the corporate tax rate to 20% or possibly as low as 15%, having reduced it from 35% to 21% when he was in the White House.
Implementing these measures will require the consent of Congress. Fiscal hawks on the Republican side might balk at the cost; such measures would cost around $5 trillion over the next 10 years, more than 15% of GDP, at a time when the national debt now stands at 123% of GDP. But we suspect this would be partially offset by the repeal of certain climate-related provisions of the Inflation Reduction Act and cuts to federal social security benefits as well as the revenue raised from higher tariffs.
Growth should also be supported by Trump’s deregulatory agenda. One of the biggest beneficiaries would be the energy sector. Trump has pledged to end delays in federal drilling permits and leases, remove limits on natural gas exports and roll back car emissions rules set to come into force in 2032. But a broader deregulatory push might be mounted after the Supreme Court overturned the 1984 “Chevron deference”, weakening the power of federal regulatory agencies. For instance, Trump is reportedly planning to further cut red tape for banks, which could spur credit growth.
Chart 6: Extending the expiring 2017 tax cuts will not be cheap
Source: Schroders Economics Group, Congressional Budget Office. 22 July 2024
Trumponomics 2.0 would push the US in a reflationary direction
If Trump were to win the election, our expectation is that US growth would be stronger and inflation firmer. This appears to be in line with the market consensus, with the yield curve steepening after both the first debate and the assassination attempt which were perceived to boost Trump’s odds of victory. But quantifying the precise economic impact is especially challenging. Not only because the Trump campaign has been light on detail, but also given Trump’s history of being overambitious in his policy promises and the pattern of unpredictability in his decision making.
As such, this has meant that we have had to make several wide-ranging, substantial assumptions about a second Trump presidency, some of which may very well be proven wrong. However, one thing that we are confident about is that most of the macroeconomic impact won’t be felt until 2026 onwards. Not only due to the time it will take to legislate and implement his agenda, but also because of the lags associated with the policy transmission mechanism eventually feeding through to activity and prices.
In terms of growth, our analysis suggests the US economy would expand by 2.2% in 2025 under a second Trump presidency. It would then accelerate to 2.7% in 2026 as the administration’s growth promoting policies kick in, before easing back to 2.3% in 2027 as higher inflation weighs on consumer spending.
On that topic, we expect an easing in core CPI inflation to 2.6% next year will prove short-lived. Our projections suggest it would rebound to above 3% in both 2026 and 2027 as the incremental increases in tariffs and wage costs are passed on to consumers.
As such, a Trump victory would be more reflationary than if a Democratic candidate were to be elected. Our expectation is that a Democratic president’s policy agenda would almost certainly be hamstrung for the first two years of their term, owing to the near certainty that the Senate will flip to the Republicans. In any event, we would expect the economy to revert to trend in the coming years under a Democratic president.
Chart 7: Trump’s policy proposals would lift growth, but also inflation
Source: Schroders Economics Group, Bureau of Economic Analysis, Bureau of Labor Statistics, LSEG Datastream. 22 July 2024
Rates would be more restrictive under Trump, at least initially
It is no secret that Trump is not a fan of Fed Chair Jerome Powell. So it came as little surprise when he confirmed that he would not nominate him for a third term if re-elected president. Trump has also recently clarified that he would not seek to remove the Fed Chair before the end of his second term, which runs until May 2026, following speculation that he might.
Still, we continue to believe that Chair Powell’s reign at the helm could be short-lived if Donald Trump ascends to the Presidency once again. Powell would become a convenient scapegoat if the economy suffers any setbacks. Good economic news might not be able to extend his time at the Fed either given that the President and his Administration could, perhaps justifiably, take credit for delivering the policies that led to those positive developments.
At the same time, Powell has stated that he plans to see out the entirety of his second term. And so if Trump were to be returned to the White House, our expectation is that the Fed will enact a mid-cycle adjustment of 75 basis points by early 2025. But we would subsequently expect rates to remain on hold under Powell’s stewardship as Trump’s tariff and immigration policies then stoke inflationary pressures.
If Harris, or another Democratic candidate, were to be elected, we would expect some further modest easing in 2026 as the Fed looks to revert to a less restrictive stance for monetary policy.
Chart 8: Tariffs and lower immigration would limit scope for Fed cuts under Powell
Source: Schroders Economics Group, Federal Reserve, LSEG Datastream. 22 July 2024
After Powell’s term ends in May 2026, however, Trump would push to replace him with a more dovish Fed Chair. He will still need to select a mainstream economist because his nominee will have to be confirmed by the Senate. During his first presidency, Trump’s attempts to appoint Herman Cain and Judy Shelton to the Fed Board failed even with a Republican Senate given their unorthodox views on monetary policy. Reports suggest that former Fed governor Kevin Warsh and Kevin Hassett, a one-time chair of the Council of Economic Advisers, have been short listed by Trump’s team.
Whether Powell’s replacement would bring about the policy easing that Trump would be looking for is debateable. Much of the Fed leadership is on lengthy terms that stretch beyond the next four years; Biden has appointed four new governors to the seven-member board, while several of the 12 regional banks also have new presidents. As such, we would expect any push to cut rates aggressively by a new Fed Chair would effectively be vetoed by the other members of the rate setting committee, unless it is warranted by the macroeconomic outlook.
Of course, the election outcome remains uncertain, though it does appear that the momentum is with Trump. And the analysis above inevitably relies on making assumptions around Trump’s policy agenda, which is itself uncertain and liable to change. However, based on what we do know, our expectation is that US growth would be stronger and inflation firmer if Trump were to win in November.
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