Financial markets were poised for days of uncertainty waiting for the final result of the US presidential election to become clear, but in the end it wasn’t even close. Donald Trump won comfortably and the reaction in the markets to his return to the White House in January was swift. Share prices rose. The US dollar strengthened. Interest rates were expected to stay higher for longer and it became more expensive to service US government debt.
The moves in the markets were also entirely predictable. The man who will become his country’s 47th president has made no secret of what he plans to do: cut taxes, impose heavy tariffs on imported goods, curb migration and slash red tape.
Trump insisted while campaigning that the economy was in poor shape, a message that resonated with many Americans unhappy about the increases in the cost of living during Joe Biden’s presidency. In reality, he will inherit an economy operating at close to full employment and with little spare capacity. Inflation is down but not quite out. The US budget deficit is on course to be 7% of gross domestic product, the highest it has been in peacetime other than during a recession.
Most economists expect Trump’s economic measures – even if they are scaled back once he is in office – will eventually be bad for growth, not only in the US but for the rest of the world too. The National Institute of Economic and Social Research, a UK thinktank, has estimated that the US economy will be up to 4% smaller as a result of the tariffs, depending on whether they are imposed in full and whether other countries retaliate.
In the short term, the stimulus provided by tax cuts and the higher prices that would result from tariffs on imports would overheat the economy, lead to upward pressure on inflation and widen the budget deficit still further. All of which explains why the kneejerk response to Trump’s victory was an increase in the yield – effectively the interest rate – on US government bonds. Bond yields tend to rise when investors anticipate higher inflation or bigger budget deficits.
But putting up barriers to trade and reducing business taxes would boost the profits of corporate America, which explains why shares on Wall Street rose. The Dow Jones industrial average and the more broadly based S&P 500 were both at record highs in early trading on Wednesday.
Higher inflation is likely to result in the Federal Reserve – the US central bank – being more wary about cutting interest rates. Financial markets still expect a 0.25 percentage point cut in US rates on Thursday but thereafter the outlook appears less clearcut.
Lindsay James, an investment strategist at Quilter Investors, said: “While he, and others that surround him such as Elon Musk, want to cut the size of the state, public spending is likely to remain very high and taxes kept low. Many of his measures will be inflationary and likely to lead to a rise in bond yields, putting pressure on the Federal Reserve in its quest to bring interest rates down.”
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The anticipation of US borrowing costs being higher for longer had an instant impact on the currency markets, where the US dollar rose strongly, especially against the euro.
The explanation for that is obvious. The 20-nation eurozone has been performing much less well than the US since the end of the Covid-19 pandemic and is vulnerable to the tariffs Trump has pledged to introduce: a 60% levy on Chinese goods and a 10% levy on goods from all other countries. Germany, an export-reliant economy, looks particularly exposed.
