Already, the US Federal Reserve is singing a more hawkish tone, reducing expectations for the number of interest rate cuts it expects for this year.      

Investors need to take a stance. Either they believe Trump’s pro-growth policies will be enough to offset the inflationary forces from his protectionist agenda, or they believe that those very same policies will lead us down a road of stagflation (a combination of high inflation, high unemployment, and stagnant demand).
 

US economy: state of play

To make an educated guess as to what markets may look like under a Trump presidency, let’s first take stock of the US economy today. 

The US economy surpassed expectations in 2024 with real Gross Domestic Product (GDP) expected to end 2024 at 2.7%. This was mostly driven by personal consumption as opposed to government spending or net exports, as seen in other countries. 

This domestic demand is more sustainable but relies on consumers keeping their jobs and spending their wages. Thankfully, real wages continue to support consumer spending and potentially point to further consumption ahead. 

This has led to an improvement in retail sales in absolute terms in the US and even against market expectations, as the charts below show:
 

The US economy remains on strong footing
US GDP grew 2.8% for Q3, supported by household spending

Source: Schroders Economics Group, Atlanta Fed, Bureau of Economic Analysis, Macrobond. 20 October 2024. RHS US Federal Reserve, Refinitiv Datastream, 07 October 2024.

Unemployment in the US has risen but remains low at around 4.1%. Most of this modest rise has come from the increase in labour supply through immigration as opposed to a sustained increase in layoffs. In fact, private sector job growth has continued to surprise to the upside, other than the October jobs data in the US which was muddied by strikes and hurricanes. 

The most recent initial jobless claims came in lower than markets expected, further cementing the strong footing of the US labour market.

Ultimately, companies cut staff when earnings are falling and profit margins are under pressure, which is not the case now for US businesses. 

Earnings transcripts for US companies (where they discuss their earnings result with analysts) generally see the intention to fire staff falling, versus a strong uptick in those looking to hire but likely waiting for more certainty in 2025, according to Schroders analysis. 

Until we see evidence to the contrary, Schroders believes unemployment in the US will remain low and the consumer will remain resilient and continue to spend in 2025.
 

Corporate outlook

US companies have also been insulated from higher rates. US businesses have collectively not reduced debt, but their earnings generally have risen as they passed on their higher input costs to consumers. 

Technology companies, which usually suffer from higher interest rates as price-to-earnings ratios readjust, benefited from rate rises as they borrowed at low interest rates and left their billions in earnings in cash accounts accruing over 5% for most of 2024. 

About 35% of US S&P 500 technology companies make more money from their cash interest than they pay out in their debt interest, according to Schroders analysis. 

US corporate default rates are falling, while earnings and margins remain strong. Companies were able to refinance their debt at cheaper rates before the US Fed even started its cutting cycle for interest rates.

Finally, inflation has fallen from a high of 9.1% in 2022 down to 2.7% at the time of writing, 0.7% away from the Fed’s long-run target. This has given the US Fed comfort to start their rate cutting cycle and they had already cut rates by 100 basis points (1%) at the time of writing. But given they’re cutting rates because inflation is moderating, not because growth is falling, this could potentially create a bullish backdrop for US growth not seen since the mid-90s. 

The US Fed is cutting rates at a time of at-or-above trend growth for the US economy, unemployment in the low-4% range and double-digit corporate earnings expectations. 
 

Risks for US equities

The biggest risk to this view is a potential increase in inflation. It’s hard to see increased spending or consumers taking on more debt without inflation rearing its ugly head. 
 

Trump is expected to be reflationary for the US economy
Risk of a recession, judged to be low previously, has further diminished

Source: Schroders Economics Group, 22 November 2024

Trump’s policies can be split into two categories: 

1. pro-growth policies such as tax cuts and deregulation, and 
2. protectionism (tariffs and immigration) which are stagflationary. 

The timing of these policies matters, as his protectionist policies can be implemented immediately with the stroke of a pen (executive order), whereas tax cuts require Congressional approval. Markets could see inflation fears hit first before pro-growth policies are enacted later. Markets are likely in for a volatile ride.

It’s also hard to decipher what campaign policies Trump will implement, but he has a mandate to deliver on his promises, so we must take him at his word. 

Trump has suggested 10-20% tariffs on all imports, with a more penal 60% tariff on imports from China. This will naturally push up inflation in the US as the cost of imported goods rises. 

However, three factors should help to blunt the inflationary impact of tariffs. Firstly, the US dollar could likely appreciate, especially against the renminbi, as Beijing would probably pursue a devaluation of its currency.

Secondly, the widening in corporate profit margins since the pandemic in 2020 could serve to absorb higher import costs. 

Thirdly and finally, goods might be routed via countries that are on more favourable trade terms with the US. It’s also believed that Trump is looking for a trade deal so the full brunt of the tariffs may never eventuate.

Trade Wars 2.0
60% tariffs on China, 10-20% baseline tariff for the rest of the world

Note: 11 tariff-impacted CPI categories are laundry equipment, other appliances, furniture and bedding, floor coverings, motor vehicles parts and equipment, sports vehicles (including bicycles), housekeeping supplies, sewing equipment and supplies, home decor, outdoor equipment and supplies, dishes and flatware.
Source: Schroders Economics Group, Bureau Of Labor Statistics, Macrobond, 22 July 2024

Immigration is a harder one to offset. Most of the improvement in US inflation over the past few months has been due to falling wage costs. 

After 2020, companies struggled to find staff and had to pay higher wages to attract talent. A spike in wage growth saw increased consumption but ultimately higher goods prices. The increase in supply of labour from immigration (legal or otherwise) has helped reduce wage costs and allowed the US Fed to cut rates. 

Limiting immigration, or at worst deporting workers from the US, could lower the unemployment rate but could also push up wage growth and therefore inflation higher. 

Under a ‘full blown Trump’ scenario, inflation could rise to uncomfortable levels, potentially crashing the US economy and markets. Thankfully, this is not Schroders baseline forecast, mainly due to Trump’s focus on the economy and the logistical impossibility of deporting millions of people from the US. 

When it comes to Trump’s pro-growth policies, it is easy to see how cutting personal tax rates could boost consumption and how lowering corporate tax rates could boost earnings. 

If executed well, even tariffs could help boost domestic consumption, potentially leading to a capital expenditure super cycle. 

Further industry deregulation under Trump could also boost borrowing and improve productivity. But these policies are not free. They could also likely see the US fiscal deficit worsen substantially by 2035, putting upward pressure on interest rates. This could work as a brake on the US economy and be potential turning point for shares and other risk assets.
 

Conclusion

Ultimately, Schroders sees higher US nominal GDP in 2025 and remains positive on the US economic cycle. However, we believe it will be a volatile ride. 

In this environment, Schroders takes a more positive view of US equities versus US bonds given the risks to inflation and fiscal deterioration in the US.