Trumponomics may provide new twists in 2025

The U.S. election and the radical economic program President-elect Donald Trump campaigned on would heavily influence macroeconomic developments in 2025 if implemented. While much of the course of the year from an economic perspective is largely baked in, reflecting the existing momentum (or lack of) of the major economies, “Trumponomics” could affect all and provide new twists. 

President Joe Biden’s administration is leaving the Trump administration with a strong economy. U.S. growth is high and reflects potential growth rather than overheating. Unemployment is low. Inflation is about 1% above target, but the Federal Reserve (Fed) was confident before the elections that it would reach 2% in 2025. Private consumption is strong, with consumers steadily reducing the excess saving built up during the pandemic, suggesting optimism. The Inflation Reduction Act and spending on artificial intelligence are leading to strong non-residential investment. 

Economic expectations 

Notwithstanding the change in government, the economy would most likely have remained strong in 2025. On the negative side however, budget deficits are large – and even ignoring the announced Trump tax cuts, the Congressional Budget Office had been predicting that they would remain large for the foreseeable future, implying steadily increased debt-to-GDP ratios. 

Starting from that baseline, Trump’s intended policies – be it tariffs, tax cuts, deregulation, or deportations, project to lead together to overheating, higher interest rates, and a stronger dollar. 

Unless countered by strong retaliation or a large dollar appreciation, tariffs would most likely increase demand, as would tax cuts and potential deregulation of the financial sector – at the cost of inefficiency in the first case, debt sustainability in the second, and financial stability in the third, but all three playing a minor role in 2025. 

Deportations, if implemented at rates anywhere close to what has been announced, will reduce labor supply and potential output. With larger demand and smaller supply, there could possibly be a resurgence of inflation in 2025. If so, it sets up a potential conflict between the Trump administration and the Fed. In my opinion, I have little doubt, at least in 2025 with Jerome Powell as Chair, the Fed will stick to its mandate and increase real interest rates, reinforcing dollar strength. 

Could the scenario turn out differently? As always, the answer is yes. One factor, relevant but difficult to quantify, is the effect of uncertainty, particularly on investment. Where and whether to invest and how to organize supply chains depend very much on access to markets, restrictions on foreign direct investment, rules of origin for exports, and so on. U.S. tariffs are likely to lead to retaliation by Europe and China and complex tariff games. Uncertainty about the outcome may lead firms to wait and suspend investment. Uncertainty about inflation may affect consumption as well. So, a slowdown in activity is possible, if not probable. 

Eurozone growth obstacles 

Turning to the Eurozone, the starting position feels very different to the U.S.: mediocre economic data and a pessimistic mood, both about economic prospects and the very limited political room to improve them. 

The unemployment rate is low by European historical standards. The issue is productivity growth, and by implication, potential growth. Since 2010, Eurozone GDP per capita has grown at 0.8%, compared to 1.4% for the U.S.. And the difference between the two has increased in the last five years, with zero growth in Eurozone GDP per capita versus 1.8% for the U.S. 

A look at disaggregated data shows that the difference has come largely from lower productivity growth in information and communication technology-intensive sectors in the Eurozone. 

Former European Central Bank (ECB) President Mario Draghi’s report into European Union (EU) competitiveness, which warns of a “slow agony” of decline if the situation doesn’t change, is resonating with policymakers. 

But its ability to implement reforms and finance the required public investment, either at the national or the EU level, is extremely limited. Consumer confidence is low. Fiscal consolidation, required under EU rules, contributes to weak demand. With inflation under control, this implies a substantially more accommodating policy on the part of the ECB. I believe current rate forecasts may be too high, and I do not exclude a return to the zero lower bound. Comparing this to the U.S. reinforces my belief of euro weakness and dollar strength. 

How would Trump’s policies affect the Eurozone outlook? The answer depends largely on the extent and form of any retaliation. Without strong retaliation, the implications are likely to be the mirror image of those for the U.S.: weaker exports to the U.S. and a weaker euro. The higher U.S. tariff on Chinese exports to the U.S. complicates the story. On the one hand, the EU may be able to replace some Chinese exports to the U.S. On the other hand, again, to the extent that China still relies heavily on exports, China may try to redirect exports to Europe. 

Rising tariffs 

Complicating the story even more, and independently of U.S. measures, Europe and China are also increasing tariffs, leading to lower exports and imports. Ultimately, the evolution of commercial wars between the three main players has yet to work itself out. For the moment, weak internal momentum appears likely to dominate macroeconomic evolutions in the Eurozone in 2025. 

Elsewhere, emerging markets look to be much more affected by Trump’s policies and the likely resulting trade wars. This is most obviously the case for Mexico but also for the countries, such as Vietnam, that counted on growing by moving up supply chains and may find themselves excluded or having to take sides.

The effects may take time to materialize. Before this happens, higher U.S. interest rates and a stronger dollar may make life harder for the countries which have high levels of dollar debt. This may be where, apart from the U.S., Trump’s policies will have the largest effect in 2025.

All data sourced from AXA IM, as of 11/25/2024