Barror's: Trump's Victory Could Ignite Inflation and Make the Fed More Hawkish
Foreks - Evaluating the U.S. presidential election results, Barron's stated, "President Donald Trump’s return to the White House could refocus the Fed on combating inflation and steer the central bank in a more hawkish direction. Particularly, Trump's proposals on immigration and tariffs could elevate inflation and create potential supply or demand shocks."
Barron's made the following assessment: “It is evident that the Fed is data-dependent; it began lowering interest rates in September and signaled a willingness to go further given the slowing inflation and softening labor market. It is unlikely that the central bank will change its stance based solely on political rhetoric and prefers to wait for the effects of implemented policies to manifest in economic reports or surveys."
Tim Duy, Chief U.S. Economist at SGH Macro Advisors, remarked, “Ending interest rate cuts due to Trump’s victory will clearly be viewed politically.”
Higher tariffs on imports during Trump's presidency could drive up the prices of imported goods. While campaigning, Trump proposed a universal 10% tariff on imports and a 60% tariff on goods from China.
Inflation, measured by the personal consumption expenditures price index, which the Fed favors, declined to an annual rate of 2.1% in September, down from a peak of over 7% in mid-2022.
Samuel Tombs, Chief U.S. Economist at Pantheon Macroeconomics, predicts that a general 10% tariff would increase PCE inflation by 0.8 percentage points, with most of the effect observed within a year of implementation.
If Trump's second term promotes U.S. oil and gas production as he promised during his campaign, it could help lower energy costs and partially offset inflation caused by other policies.
If progress on inflation halts, the Fed may have to decrease interest rates less than the markets currently anticipate in the coming years. And if inflation rises again, it may need to raise rates again.
Trump’s tax and spending proposals would widen the federal budget deficit and potentially increase demand in the economy, leading to higher bond yields. Among Trump’s tax plans are the extension and expansion of the 2017 Tax Cuts and Jobs Act, as well as tax exemptions for overtime, tips, and Social Security income. The nonpartisan Committee for a Responsible Federal Budget estimates that Trump’s proposals could increase the national debt by $7.8 trillion over the next decade. Adam Abbas, Director of Fixed Income at investment firm Harris Associates, stated, “Increasing spending risks exacerbating the inflation issues we’ve previously dealt with.”
Treasury yields increased in the weeks leading up to the election as betting markets moved to favor Trump’s victory. Simultaneously, strong U.S. economic data made it challenging to disentangle the election's impact on yields.
Abbas believes that at some point, the bond market will force a discussion on the budget deficit. He noted, “It may be a point where bond vigilantes put pressure on politicians to look at spending, but trying to nail down the timing of that is a tough game.”
The Federal Open Market Committee, which sets Fed policy, will announce its next interest rate decision on Thursday. The futures market overwhelmingly prices in a quarter-point reduction in the federal funds rate target to a range of 4.5% to 4.75%.