Trump will present his plans on Monday. Much will depend on these plans for the financial markets. So far, markets have assumed they will be positive for the economy and business, and have already priced in some of the effects.
In terms of the economy, it is striking that as soon as Trump started gaining a significant chance at the presidency, consumer and business sentiment indicators began to improve. This likely contributed to the recent positive growth figures from the U.S. So far so good, but how will the Fed view this?
Contrary to expectations a few months ago, the U.S. economy has not slowed down. The expectation was that growth would slow to around 2% due to high interest rates, but in practice, it has remained around 3%. If Trump now proposes measures that further boost growth, it is quite possible that it could rise to 3.5% or 4%. Since the U.S. economy is already operating at full capacity, this will lead to imbalances that could result in a recession. It is the Fed’s job to prevent this. This is important now because the Fed has estimated potential growth at around 2% for the coming years.
Potential growth consists of the sum of the increase in the labor force and productivity. However, different perspectives can be taken on this:
Labor force: Due to aging, the increase in the labor force is quickly slowing down. What will happen with immigration? Trump wants to limit it as much as possible and also deport illegal immigrants. If he follows through on this, it could significantly reduce potential growth. The question is whether this will remain rhetoric or lead to actual action. We expect that it will indeed lead to real measures, which will have important implications for Fed policy. Over time, we will see to what extent this will actually play out.
Productivity: This is an even more uncertain factor. Markets have been optimistic for a long time, expecting a boost from Artificial Intelligence. While there is indeed substantial investment in this area, most experts don’t believe it will lead to significant economy-wide productivity gains in the coming years. However, the markets are much more optimistic about it. Moreover, Trump and his advisors believe that many of their plans will also lead to higher productivity growth. We are somewhat skeptical about this, as similar expectations in the past did not materialize. On the other hand, despite around 3% growth, inflation in the U.S. has remained around 3% for some time. In any case, the economy shows few signs of rising or falling inflation.
Has the Fed perhaps underestimated potential growth, and can the economy grow at 2.5% to 3% without exerting too much upward pressure on inflation? We would be cautious about jumping to this conclusion, as it was previously assumed that economic growth would decline, which kept wage demands in check. Now, the opposite seems to be happening. Furthermore, the labor market could tighten more quickly if Trump moves forward with his immigration plans. Finally, import tariffs could also push inflation higher. All of this hinges on a much higher increase in productivity.
The conclusion we draw from all of this is that careful attention must be paid to what Trump actually presents and the likelihood that Congress will agree to it. Hopefully, we will know more next week. It is clear, however, that growth in Europe is much lower and is at greater risk due to potential import restrictions that Trump may impose. Unlike the Fed, the ECB will likely need to continue lowering interest rates for the time being.
