In a previous article, we highlighted that most major economies end 2024 in the “Goldilocks” zone – not too hot (inflation and labor markets), not too cold (economic growth) – And they will enter 2025 with strong momentum.
For the United States in particular, 2025 could be a year of change, in part because of the election. So we wanted to see what the proposed policy changes would mean for the economy.
US election expected to increase uncertainty
President Trump’s 2024 campaign includes multiple proposals for major reforms to trade and immigration policy, including sweeping 10% tariffs, a 60% tariff on China, and tighter immigration controls, particularly on unauthorized immigrants .
All things considered, this isn’t all that different from the policies we saw in the first Trump administration, which imposed tariffs on China, renegotiated NAFTA, slowed immigration, and beefed up border security.
Trump used tariff proposals as a negotiating tool to win concessions from other countries during his first term, so not all proposed tariffs will ultimately be implemented. Most expect this to be the case over the next four years as well.
However, this may increase uncertainty, especially for companies with international supply chains. The trade policy uncertainty index soared during Trump’s first term as president, reaching a record high before taking office (see chart below).
President Trump’s platform also includes lower taxes and regulation — both things that are likely to be good for business and therefore the stock market.
Check out the data for Trump 1.0 to see how Trump 2.0 works
The latest experience from President Trump’s first term provides an example of the economic impact we can expect from his second term.
We can start with tariffs, which were targeted primarily at China during President Trump’s first term.
The additional cost of importing from China forces companies to change suppliers or supply chains. Over time, this resulted in China’s share of U.S. imports of goods being almost halved to 13% (below, red line).
However, many countries benefited, including China’s neighbors (Taiwan, South Korea, Vietnam) as well as Mexico (“near-shoring”) and the Eurozone (“friendly-shoring”).
President Trump proposed broader tariffs during his second term. Many economists expect Trump to focus on countries with larger net exports to the United States as a way to narrow the trade deficit and strengthen U.S. supply chains.
If so, the chart below shows the countries that trade the most (country size) and those with the largest U.S. trade deficits (dark red). Based on this, countries such as Mexico, China and Vietnam are considered the most likely focus. In fact, Trump has proposed imposing higher tariffs of 25% on Canada and Mexico.
Importantly, tariffs will be an additional cost for U.S. companies that import goods from abroad. For companies, in order to maintain profits, they try to pass these costs on to customers.
Therefore, tariffs are expected to increase inflation. While the price increase may be a one-off, considering manufacturing only accounts for about 10% of the U.S. economy, the impact on overall inflation may not be as large as many think.
Immigration restrictions may reduce labor supply and raise wages
Another potential reason for rising costs is immigration restrictions. The most obvious impact of tighter immigration controls, especially deportations, will be a reduction in the labor force.
An interesting parallel to the first Trump administration is the economic impact of the coronavirus pandemic. The COVID-19 pandemic has significantly reduced the labor supply in three ways:
- An estimated 2.4 million people are retiring early (rather than risking illness).
- Increased unemployment benefits allow people to persist in their search for the perfect job.
- Due to global travel restrictions, visa issuance volumes in 2020 and 2021 fell by more than 50% compared to 2019.
Taken together, once the economy recovers, it will lead to a severe labor shortage. At the peak of the recovery, once vaccines are widely available, there will be two The number of job vacancies per capita of unemployed people was 1.2 in 2019.
Since there is a high demand for fewer workers, those who are willing to change jobs are able to earn higher salaries. Therefore, by 2022, the salary growth rate of job changers will increase to 8.5% per year (chart below, purple line), and the salary growth rate of job stayers (black line) will also increase. Data shows that corporate wage costs have increased by 25% since 2020, exacerbating the “sticky” inflation we will see in 2024.
However, Trump’s immigration restrictions should be just a mini version of what we’ve seen during the COVID-19 pandemic. According to some reports, since 2021, the United States has averaged about 1.4 million illegal immigrants every year, many of whom may not have yet joined the labor force.
However, where deportations are more widespread, the industries reported to be most reliant on illegal immigration are professional services, leisure and hospitality, construction and agriculture.
The higher wages needed to lure people back into these industries could also fuel inflation. However, the consensus is that this will be much milder than the wage inflation we see in 2022.
Lower taxes, deregulation and mergers and acquisitions are good for stocks
Most other policies proposed by Trump should boost company valuations.
Given President Trump’s pro-business platform, many expect him to reduce regulatory restrictions. This will reduce the company’s costs. Because M&A transactions typically involve the purchase of stock at a premium to market price, the price of a potential acquisition target may increase due to the possibility of a new deal.
Tax cuts are also expected to boost businesses and the economy.
Not only does President Trump want to make permanent his 2017 tax cuts that are set to expire in a year, but he also wants to further cut the corporate tax rate from 21% to 15%.
Interestingly, the year after Trump lowered the corporate tax rate from 35% to 21%, we saw corporate profits grow significantly, from 11% annual growth in 2017 to 21% in 2018 (below) green bar). For every 1% reduction in tax rates, profits will increase by nearly 1%.
That said, corporate profits fell slightly (1%) in the year after Trump imposed most of his tariffs (Red Bar, 2019).
What is the market saying? Higher growth, inflation and interest rates
Most economists agree that deregulation and tax cuts should boost economic growth (and corporate profits). However, tariffs and immigration restrictions are likely to increase inflation (at least in the short term) and could reduce trade and growth in the longer term.
The market seems to agree. Short-term and long-term interest rates have moved in opposite directions over the past few months.
We’ve seen the Fed cut interest rates by 100 basis points over the past few months (including 25 basis points today) to 4.5% (chart below, red line), with rates falling closer to “neutral” territory (likely 3% (around), further interest rate cuts are expected.
At the same time, however, long-term rates (the 10-year Treasury yield) rose 80 basis points (black line). This suggests that market expectations for strong economic growth and rising inflation over the next decade exceed our pre-election expectations.
In light of this, markets now expect the federal funds rate to fall to 3.95% over the next 12 months, a full percentage point higher than expected in September.
Can the labor market support consumers to continue spending?
The big question is whether higher interest rates will slow economic growth more than the boost from tax cuts and deregulation.
Data shows that rising interest rates are disproportionately affecting smaller companies. Many people are paying much higher interest rates on their loans, causing incomes to continue to decline. As a result, small businesses, which employ nearly half of America’s workers, appear to be scaling back their hiring plans.
But this is not the main reason for the rise in unemployment. Instead, higher wages attract more workers back to work. In fact, companies are still hesitant to lay off workers, with layoff rates near record lows (red line in the chart below).
U.S. consumer spending is the primary reason the U.S. economy is stronger than many other developed economies. That strength now appears to come from a strong job market and rising wages.
For the economy to remain stable in 2025, we need the labor market to remain strong.
Further interest rate cuts and tax cuts may be just what we need to keep the U.S. economy growing for at least another year.
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