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Written by: Tim Pierotti
Following President Biden’s disastrous debate performance last week, markets have already begun pricing in the increased possibility of another Trump Presidency. While it has only been a couple trading days since the debate, it is notable that despite a PCE reading on Friday that appeared in every way benign from a near-term inflation perspective, ten-year yields are up by over 20 basis points from the lows of last week (as of Noon on 7/1).
Perhaps markets are already beginning to reflect what 10% “across the board” tariffs would mean to inflation and rates. Recently my former colleague and Deutsche Bank’s Chief US Economist wrote to clients regarding Trump’s tariff heavy agenda,
“Such a shift could counteract at least some of the very positive supply dynamics that are currently allowing strong growth to coincide with disinflation. With inflation already well above the Fed’s target, and upside inflation risks still top of mind for monetary policy makers, we see trade policies as possibly adding another reason to keep the Fed on hold into 2025.”
The bank’s economics team believes that the implementation of trade policies as described by the former President’s campaign will result in inflation rates rising somewhere between 100 and 200 basis points in the PCE. Just to be clear, the low-end of those estimates would take the current 2.6% rate up to 3.6%. How many cuts do you think the Fed would be contemplating with inflation running almost 2x their target?
Tariffs and protectionism broadly speaking are core to Former President Trump’s plans for the US economy. The basic argument is that decades of “Free trade” or “Neoliberalism” has allowed a hollowing out of US manufacturing and, in turn, American manufacturing jobs. There is clearly some undeniable truth to that observation. That said, it is also undeniable that the US enjoyed decades of falling inflation and importantly, significantly higher standards of living, corporate profits and, on average, wealth accumulation. My intent is not to referee the merits of free trade versus protectionism but to make the point that there are trade-offs. It is also worth mentioning that the migration to a nationalist industrial policy has already started under President Biden (think CHIPS, the IRA and tariffs on various Chinese products).
But protectionism is only one piece of MAGAnomics. Tariffs are not to only serve as a means of protecting domestic manufacturing, but also as a revenue replacement for lower taxes via the extension of the Trump led tax cuts from 2017 that are set to expire next year. It would be an understatement to say that there are few mainstream economists who believe that tariffs could be an effective means of reducing deficits.
The other important populist piece of MAGAnomics is sharply reduced legal immigration as well as the full closing of our southern border and finally “mass-deportations” of immigrants in the US illegally. More than 100% of the job growth in the US since 2019 has come from the foreign born. The issue is not that Americans don’t want to work. In fact, labor participation among Americans aged 24-55 is right around the highest levels of this century. The issue is demographics. Baby-boomers are retiring en masse and falling family formation and fertility rates means there are not enough young American-born workers to replace them. Therefore, if we sharply curtail immigration, corporations will face the risk of a wage price spiral, given wages are already running hot.
The point here is that we are embarking on an experiment, a massive economic experiment that if executed will be transformative to not just the US economy, but to the world. It is an experiment that clearly resonates with voters, but it may also be an experiment that brings the unintended consequences of higher inflation, soaring budget deficits and a less cooperative global community.
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