Now that US President Donald Trump has taken office, markets and the economy have a new and very different driving force. Forget about the US Federal Reserve. The US’ outlook would depend much more on how, and to what extent, the president puts his plans on everything from tariffs to deportations into action.
What to expect? That is a very difficult question. Nevertheless, one can make an educated guess. Here is mine.
Trump would take tariffs much higher than before — to at least 10 percent of aggregate imports, compared with 3 percent in his first term. He is genuinely a fan, seeing them as a great negotiating tool and income generator. His government needs the revenue, given projected budget deficits of about 6 percent of GDP over the next decade (and that is assuming no extension of the 2017 tax cuts). As a result, inflation would probably run 25 to 50 basis points higher over the next year, as importers pass on costs and protected domestic producers raise prices. This price shock would come at a time when inflation is already above the Fed’s 2 percent target. It would depress consumer spending, especially for lower-income households that have no savings buffer and spend more of their income on imported goods.
Trump would follow through on deportations, but I expect less rather than more. Ejecting millions of people from the US is logistically difficult. A committed effort would take years, not months, and the resulting labor shortages would be too economically damaging. Still, even a smaller number — say, focused on convicted criminals — would exacerbate a shortage of workers that is limiting growth. Together with former US president Joe Biden’s crackdown on border crossings, the retirement of baby boomers and the already elevated participation rate among prime-age workers, modest deportations could hold the annual increase in the labor supply to less than 0.5 percent. This implies a maximum real GDP growth rate of just 1.5 percent to 2.5 percent.
Trump and Congress would extend the 2017 tax cuts, but would not enact other costly campaign promises, such as reducing taxation of social security benefits and tips. Given the dire budget outlook, some Republicans would balk at added tax cuts without offsetting spending cuts, which would be hard to agree on. Consensus is lacking: House and Senate Republicans have differing appetites for fiscal probity, while Democrats are likely united against bigger tax cuts (with the exception of increasing the state-and-local-tax deduction).
For this year, all this suggests a difficult economic trajectory. Expect higher inflation, elevated interest rates, slower growth and more volatility as markets and the Fed struggle to adjust to Trump’s pronouncements and actions. In short, prepare for turbulence ahead.
Bill Dudley, a Bloomberg Opinion columnist, served as president of the Federal Reserve Bank of New York from 2009 to 2018. He is the chair of the Bretton Woods Committee, and has been a nonexecutive director at Swiss bank UBS since 2019. This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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