The Republican sweep in U.S. elections will lead to a shift in U.S. economic policy, which will boost short-term economic growth, but could prove detrimental to the outlook for much of the rest of the world, especially if U.S. trade policy turns decisively and lastingly protectionist. On November 5, the Republican party won the presidential and congressional elections. The president-elect is widely seen to have won a decisive mandate for economic policy change, the electoral remains deeply divided and polarized. The Republican majorities in the House and the Senate are small, but will prove sufficient to push through wide-ranging changes, to the extent that this does not require overcoming a Democratic filibuster in the Senate.
> Republican presidential candidate Donald Trump won the popular vote for the first time since the re-election of GW Bush in 2004 and won all swing states. Republicans also took over the Senate and to maintain their majority in the House, where they are projected to control 220 out of 435 seats. The Supreme Court remains dominated by Republican-appointed judges (six versus three).
Unified Republican government will have significant leeway to implement Republican economic policy preferences on fiscal policy, deregulation and trade. Unified government will allow the Republican party to push through wide-ranging changes to economic policy, including immigration policies. Moreover, the president will make significant use of executive power in terms of trade and deregulation. The president-elect has pledged to impose broad-based tariffs on U.S. imports, cut taxes, deregulate the economy, particularly the Biden administration’s green transition focused spending, crack down on immigration and take a less restrictive stance on anti-trust policies. The president-elect (or advisor close to him) has also suggested replacing income tax with tariffs, taxing foreign holdings of U.S. financial assets. The new administration will have the greatest latitude to bring about a shift in fiscal policy, which will translate into tax cuts, but at best limited spending cuts. On trade, the government faces statutory constraints in terms of imposing across-the-board tariffs. On regulation and anti-trust policy, the government can repeal existing legislation or make use of executive decrees to block parts of existing legislation, like the Inflation Reduction Act. On other policies, the Republicans will need to overcome Democratic opposition in the Senate.
> Trade policy during the first Trump administration used to protectionist threats and policy measures to renegotiate existing trade agreements (NAFTA, Korea, Japan) or agree to negotiate a trade agreement (European Union). But trade policy also led to the imposition of high, across-the-board tariffs on Chinese imports and sector-specific tariffs on steel and aluminum, and other goods. Given the new administration’s protectionist implications, trade tensions on other issues, such as digital taxes, will increase. In order to impose broad-based tariffs, the president needs to declare a national emergency. Existing trade legislation does not give the president the authority to impose across-the-board tariffs.
> The bulk of spending tied to the Biden administration’s Inflation Reduction Act benefits Republican states, which may lead the Trump administration to target selective provisions rather than all IRA-related spending. There is also significant corporate pushback to repealing the CHIPS and Science Act, which largely aligns with the pro-domestic manufacturing stance of the Trump administration. The Republicans do not have a filibuster-proof majority in the Senate, which will force them to negotiate legislation, outside of what can be passed through budget reconciliation.
If the Republican administration succeeds in implementing its preferred tax, immigration and trade policy, inflationary pressure will increase, leading to a stronger dollar and higher U.S. interest rates. An expansionary fiscal policy and a crackdown on immigration will put upward pressure on inflation, leading the Federal Reserve to slow down and perhaps reverse interest rates cuts. If the tax cuts prove extensive and spending cuts paltry, a wider deficit will put upward pressure on government debt and hence increase the risk premium on long-term government bonds. Tax cuts and deregulation have the potential to raise short- and medium-term economic growth, but large-scale tariffs (and foreign trade retaliation) and concomitant economic uncertainty may lead to a weakening of the economic outlook, at least in the medium term. Though unlikely given the legal-institutional autonomy of the Federal Reserve, a successful policy of putting pressure on the Federal Reserve to pursue a more dovish monetary policy could further undermine medium- and long-term financial and monetary stability.
> U.S. fiscal deficits will increase further leading to a more rapid increase in federal government debt, particularly once economic growth converges to its medium-term potential of 2%. The administration is all but certain to make the 2017 tax cuts permanent and may cut other taxes, while at implementing only limited cuts to federal spending. an is in the White House. Federal spending only account for ¼ of federal spending, meaning that significant changes would be required to offset the fiscal effects of making the 2017 tax cuts permanent.
> The macroeconomic policy mix, particularly if combined with protectionist trade and hawkish immigration policies will be negative for fixed-income markets, given the potential for upward pressure on long-term interest rates. Provided protectionist policies do not prove too detrimental to economic confidence, an expansionary fiscal policy, highish interest rates and deregulation should provide a short-term boost to economic growth in the context of higher-than-anticipated inflation, which should benefit equities, broadly speaking. Moreover, deregulation, corporate tax cuts and a less hawkish anti-trust policy should benefit selected sectors, such as banks, fossil fuels, among others, while the repeal of ESG-related rules and legislation will be negative for ESG-related sector and equities.
A stronger dollar, higher (relative to baseline) U.S. interest rates and higher U.S. tariffs will have a negative effect much of the rest of the world, and particularly countries with large dollar-denominated debts. A stronger dollar will put greater strain on economies with larger dollar-denominated debt given the higher cost of servicing their debts and the strain a stronger dollar puts on their balance sheet position/ net worth. A stronger dollar also typically leads to a fall in commodity prices further hurting emerging and especially developing economies relying on commodity exports. While a stronger dollar and stronger U.S. dollar could help offset some of the increased financial distress, higher tariffs on U.S. imports would sharply limit the offset. Countries with net dollar obligations would take hit on both their capital account (lower financial inflows) and their current account (lower exports). This would be greatly magnified if the Trump administration were to impose exorbitant tariffs on imports from China, as this would slow Chinese growth. As China is the dominant trade partners of more than 120 countries around the world, emerging and developing economies would suffer due to reduced Chinese demand. Much will therefore depend on how extensive and how permanent U.S. tariffs will prove. Both the EU and China, the world’s second- and third-largest economies, are currently in a weak and vulnerable position and a trade war would likely push the EU into recession and could reduce already weakening Chinese economic growth by as much as half.
> Although recently, the relationship between U.S. valuation and commodity prices exhibited an unusual pattern, with dollar strengthen coinciding with higher commodity prices, this pattern is unlikely to hold in the future, outside the energy complex.
> China is the dominant trading partner of more than 120 countries. A significant slowdown in China due to U.S. tariffs would have a negative knock-on effect on the rest of the world. While most emerging markets will be able to ride the negative effect of U.S. economic policies due to their manageable foreign debt position and generally flexible exchange rates, many developing countries could face renewed financial distress, including emerging economies currently undergoing IMF reform, such as Argentina, Pakistan and many African countries
> The IMF projects euro area growth to recover from 0.8% in 2024 to 1.2% in 2025. A trade war or even just uncertainty about U.S. trade policy and the prospect of a transatlantic trade war makes this forecast look optimistic. The IMF also forecast Chinese real GDP growth to slow from 4.8% this year to 4.5% in 2025. However, thus far limited appetite for additional stimulus means that significant U.S.-China trade tensions, and particularly a 60% tariff on U.S. imports from China, could reduce Chinese economic growth by more than 200 basis points.