How Donald Trump’s Return Could Shape the Economy and Markets

by Jim Nelson of Euro Pacific Capital, 11/13/24

As Donald Trump returns to office, he steps into an economic environment with unique strengths and opportunities, as well as challenges that may shape markets in both the short and long term. With consumer spending remaining strong, corporate profit margins expanding, and inflation showing some temporary cooling, we believe Trump’s policy agenda will impact growth and inflation dynamics in complex ways. Here’s our outlook on what to expect and how investors might navigate this new phase.

1. A Resilient Economy Sets the Stage

Trump is re-entering office with an economy that’s already on strong footing. The U.S. consumer, bolstered by record cash reserves from pandemic stimulus and relatively fixed-rate debt, remains resilient, fueling steady retail spending. This stability, paired with improving corporate profit margins, indicates that businesses are efficiently managing costs even as they pass on some inflation-related price hikes to consumers. Moreover, inflation has recently cooled on a year-over-year basis, aided by easier comparisons and temporary dips in energy prices. This moderation, though likely transient, has fostered a “Goldilocks” economy—one that’s neither too hot nor too cold—allowing risk assets, including international markets, to deliver robust returns this year.

Despite this favorable backdrop, it’s essential to recognize that these strengths developed independently of Trump’s policies, underscoring that his administration is walking into an economy already moving forward under its own momentum.

2. The Impact of Growth-Oriented, Inflationary Policies

While Trump’s intended policies are generally positive for growth, they carry potential inflationary consequences. His proposed tax cuts and deregulation efforts are likely to increase corporate profits, which could fuel more business investment and spending. For sectors such as manufacturing, energy, and construction and financials, reduced regulations may encourage expansion and drive growth. However, these policies also introduce inflationary pressure. Tax cuts increase disposable income, which can stoke demand and push prices higher, especially if supply cannot keep pace. Deregulation may also encourage faster growth but risks higher prices as production costs rise.

On the trade front, while Trump’s tariffs and other protectionist measures aim to support domestic production, we remain skeptical that these policies can offset the loss of revenue from tax cuts. Furthermore, efforts to reduce government spending may trim the deficit marginally, yet they are unlikely to be sufficient to meaningfully address the massive pro-cyclical deficit set in motion by prior administrations. History has shown that these kinds of deficits, especially during periods of growth, tend to amplify inflation and lead to rising interest rates.

If inflation cools less than expected, the Federal Reserve may be forced to take a more hawkish stance preemptively, which would likely keep rates elevated. This, in turn, would exacerbate the deficit, as higher rates lead to increased interest expenses on the already outsized national debt. In this scenario, the government’s borrowing costs would consume an even larger portion of the federal budget, potentially creating a vicious cycle of high-interest expenses fueling further deficits and, ultimately, higher inflation expectations. This could place additional pressure on both the economy and markets, particularly those sectors most sensitive to rate changes.