- Geopolitical Strategist
United Kingdom, Institutional
Change
The views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk.
Episode notes
In the wake of the US election, macro strategists Juhi Dhawan and Michael Medeiros join host Thomas Mucha to discuss the market, policy, and geopolitical implications of Trump 2.0.
In this episode:
1:15 – Equity market: Potential winners and losers
3:35 – Outlook for fixed income and bond yields
5:00 – Fiscal policy implications
6:30 – Deficits and the bond market
7:30 – Immigration’s impact on growth and inflation
10:15 – Tariffs and trade policy
13:10 – Geopolitical risk
15:30 – Fed policy in Trump 2.0
Transcript
THOMAS MUCHA: The US election is over, and we now know that Donald Trump will serve a second term as the 47th president of the United States. Strong turnout at the polls, particularly among the Republican base across all the swing states, carried Mr. Trump to victory. Now, for his second term, President Trump will have a Republican controlled Senate and potentially, pending results, GOP control of the House as well. Joining me to talk about what this outcome is likely to mean for markets, for policy, and for geopolitics for the next four years are Juhi Dhawan and Mike Medeiros, veteran macro strategists at Wellington and two of my favorite people to talk to about these topics. Thank you both for being with us here on WellSaid
MICHAEL MEDEIROS: Thanks for having us.
JUHI DHAWAN: It's great to be with you, Thomas.
THOMAS MUCHA: All right. Let me start with you, Juhi, and let's get into the market impacts that we've seen so far. What are your impressions of that and what are the sectors that might benefit or lag in a Trump 2.0?
JUHI DHAWAN: I think the first thing that the market is heaving a sigh of relief on is the fact that there seems to be a clarity of who has won the election in a relatively short period of time. There was a concern ahead of time that this could be a very prolonged process, and we are still gathering the final votes on the House side. But I think this does make a difference, that there is clarity at the top of the ticket. In terms of sectors, I would say the relative winners include those sectors that are going to benefit from a push towards deregulation. Some of these include areas of financial services, but also in the energy field. So let me touch on each of these briefly. In financial services, capital requirements could be less onerous for banks going forward. But also a shift in the regulators for areas like consumer finance could be beneficial. In the field of energy, I would expect to see more of an equalization between fossil fuels and green energy. I also think nuclear probably gets a lift. And the possibility is that the ban that was placed on natural gas exports gets lifted. Past these sectors, defense spending also gets a boost. Within health care, I think Medicare does well. And when I think more broadly, across these sectors, there's a common theme of really seeing less regulation and a little bit more of the private sector having the opportunity to determine outcomes going forward. On the relative loser side, I would say retail goods, manufacturing, and semiconductors might face the possibility of increased tariffs. So this is something that I think we'll come back to talk a little bit more in detail, but that's something to keep in mind. I would also say that green energy in general has a little bit of a lag here. Given the importance that sector gained under a Biden administration and the stated intent of President Trump to equalize the path between fossil fuels and green energy.
THOMAS MUCHA: So a lot for equity investors to sort through winners and losers. Mike, what's your view on the outlook for fixed income and for bond yields?
MICHAEL MEDEIROS: So there's already been a pretty significant increase in yields in the run up to the election. Now, part of that was due to an increased probability that the market had on not only Trump winning, but a Republican sweep as well. And then that happened to coincide with the Fed frontloading cuts and seeing some signs of a positive reflex in some of the economic data. And so that combination has been pretty powerful. But I think it's for a good reason. We saw a continuation of that overnight. Treasury yields – ten-year yields are up about 80 basis points since mid-September. So it's been a pretty significant move. And about a fourth of that was over the last 24 hours. The important piece and Juhi touched on some of this is, you know, why have bond yields gone up? It hasn't necessarily been about increased growth expectations. A lot of it's been about breakeven inflation and inflation expectations rising. And I think both can continue. Nominal yields can continue to rise in the context of even higher breakeven inflation rates. Partly because of the policy outlook which we'll get to. But namely, you know, if you have the combination of supply side cuts from increased tariffs, labor supply constraints from immigration restrictions and potentially deportations, combined with fiscal easing, which I think will happen regardless of whether the House flips or not. That's a pretty good recipe to have sustained higher inflation over the next few years.
THOMAS MUCHA: With higher rates.
MICHAEL MEDEIROS: Definitely. Yeah.
THOMAS MUCHA: Juhi, how are you thinking about the fiscal policy implications? What are you keying in on right now?
JUHI DHAWAN: First order of business is finding out whether this will be a Republican sweep, or whether this will be a divided Congress.
THOMAS MUCHA: That matters.
JUHI DHAWAN: That matters a lot, Thomas, because we are going to be facing a fiscal cliff at the end of 2025, when the original Trump tax cuts on the individual side expire. So no matter who comes into Congress, this is going to be an important piece of legislation that needs to pass next year. If it were to be a sweep, I think the size of the majorities in both houses can determine how much flexibility President Trump will have in determining the contours of this policy legislation. If it were to be a divided Congress, I think there will be a little bit more of negotiation and give and take between the Democratic Party and the Republican Party in determining if we are going to have these tax cuts extended, which is President Trump's stated goal, what will the Democratic Party want in exchange? For instance, could it be that the IRA spending plans that President Biden put in place also get preserved as a result of this type of negotiation? So the contours will be about the type of tax and spending shifts, but will be also about the size of the fiscal deficit. And that goes back to what Mike referenced earlier because the bond market cares a lot about the size of the fiscal deficit when the starting point of the deficit in the United States is already at a pretty elevated level.
THOMAS MUCHA: What pieces of this are most relevant to the bond market and how
you're looking at this, Mike?
MICHAEL MEDEIROS: All of the above. I mean, the bond market cares about fiscal policy now. And so, it's everything Juhi mentioned is really important. If you look at the CBO forecasts right now, debt levels are set to rise to about 120% of GDP. And under Trump's stated plans, which includes not only an extension of the Tax Cuts and Jobs Act, but also additional tax cut measures, particularly around taxation of overtime that could rise to 130%. And this is in the context of the CBO also assuming 4.5% nominal growth, no recession, over the next ten years, which would equate to 5 to 7% budget deficits. And so those numbers can get worse, right? We've seen term premium in the bond market start to pick up. Some of it does reflect concerns around supply of government bonds in the context of these deficits. And barring a significant change in a short period of time, I don't see any impetus for that to slow down.
THOMAS MUCHA: So we've talked about deregulation, a Trump priority. Immigration is another Trump priority. How are you both thinking about the macro implications of a more restrictive immigration policy? Mike, let's start with you.
MICHAEL MEDEIROS: Let me take a step back, right? Historically, we've really just had to focus on aggregate demand because the supply side of the economy has been pretty slow moving. That includes the labor force and productivity. Over the last few years, there's been as much volatility in the supply side of the economy as there has been in aggregate demand. And I think that'll be a feature of the next few years. And the labor force and immigration plays a big role in that. And so when immigration fell in ‘21 and ‘22, that, among other things, contributed to some of the sustained inflation we saw. Then over the last years, immigration has picked up, that really helped generate disinflation without the need for a significant output gap. Now take the election out of it. Immigration levels have likely already peaked. You can see that in the southern border apprehension data, and they're set to come down. And the CBO forecasts are going to come down. And that's without any changes in policy. And so it's hard to quantify how much it would fall. But my best sense is that, if nothing changes, immigration levels should fall by about 50% between 2024 and 2025. And then with Trump's more restrictive plan and even deportation plan, it could fall about 75%. And so all else equal, that would, I think, lead to a worse growth inflation trade off, meaning growth comes down, but domestic inflation stays stickier, all else equal.
THOMAS MUCHA: You agree with that, Juhi?
JUHI DHAWAN: I do. I think what I would really want to emphasize here is that many developed countries, including the United States, have entered an era of relative labor scarcity. And in an era of relative labor scarcity, targeted immigration, or mindful policies around immigration are going to be very important to determine the path of relative success in terms of growth and inflation. And so this white swan event that I think about when we got a surge of immigration, it turned out to be an economic blessing, even though it was a political nightmare in the election that we have just witnessed. So what I would really say is we're going to have to watch the balance from a Federal Reserve standpoint between this labor supply and where it ends up and what is a sustainable path of labor demand in that context. To make sure that the Federal Reserve keeps policy at a level which keeps the unemployment rate relatively steady and doesn't have to deal with reigniting inflationary pressures because the labor market got too tight again.
THOMAS MUCHA: So the third priority, of course, of a second Trump administration is likely to be tariffs, trade. This administration is likely to be significantly higher in terms of the number and size of these tariffs. How are you both thinking about that from a macro perspective, Juhi?
JUHI DHAWAN: Tariffs are a really tricky question for economists because they serve as a tax hike effectively on the consumer if they're all passed on to the consumer. And if they're not passed on to the consumer, they are going to serve as a hit on profitability for companies who have to absorb them in their margins. Most economists like to believe that free trade is the more efficient solution across the world, but we live in unusual times. And what we have seen in the last 8 to 10 years has been a steady increase in deliberate US industrial policy. This started with President Trump's first term, when tariffs were first introduced. But President Biden took the other side of it by introducing, subsidies in many of his policies. So I think the escalation of tariffs can have material impacts on reshaping global trade and in the dependance of specific countries and trading relationships for the United States on a bilateral basis. This has spillover impacts from supply chains, to profitability of companies, to creating more volatility and uncertainty around a number of traded goods that we have taken for granted. So the macro impact is both on growth but also on inflation. And that makes it particularly tricky to think about the trade off.
THOMAS MUCHA: Mike, what are the signals you're looking for on the tariffs side that might indicate size and scope and scale of these?
MICHAEL MEDEIROS: Yeah, like one push back would be “Well, he did tariffs in his first term. There wasn't really any discernible impact on growth and inflation. So what's the big deal?” The tariffs he's talking about now are, you know, multiples of what he implemented in his first term. We're talking 10% to 20% across the board. Potential carve outs for Canada maybe Mexico, but even up to 50% for a place like China. You add that up and direct costs is 1% to 2% to inflation next year. So the numbers are just much bigger. Now, of course, that could be the starting point in a negotiation. But to your question on what signals are we looking for? You know, for me, in the near term, we're going to see a lot of speculation on Trump's cabinet. And for me, it's very important where someone like Bob Lighthizer ends up. The more senior position he has in the Trump administration, I would take that as a signal. The more serious they are about at least to start implementing a significantly restrictive trade policy agenda.
THOMAS MUCHA: Yeah. So watch where Lighthizer lands.
MICHAEL MEDEIROS: Yeah. And, you know, as you've pointed out, right, there's a very strong relationship between restrictive trade policy and global conflict. So maybe to you, Thomas, how do you think that feeds through into the geopolitical backdrop?
THOMAS MUCHA: I think the tariffs piece of this, Mike, is pretty significant from a geopolitical perspective because it signals a pretty significant departure from Biden administration foreign policy, right? The Biden team has really been all about working with allies in multilateral ways, coordinating actions. And President Trump will be levying tariffs on some US allies. So that's likely to add more frictions. And, of course, we'll see where the China tariffs land. But I think they're looking to demonstrate economic pain that the United States can impose on China as a way to gain leverage. And so this is a significant shift from what we've seen over the past four years. What's different about this, of course, is that the current geopolitical environment is far more complex, far more unpredictable, and a lot more violent, than it was in the first Trump administration. So what will a more transactional, a more muscular US foreign policy look like? These are questions. I'm also looking at personnel. Personnel is policy. We'll see who ends up where. But I do think that Ukraine is the first issue that comes to mind. I think Ukraine will come under increasing pressure from the Trump administration to try to negotiate an end to that conflict. I still believe battlefield outcomes will drive that issue. I think we'll see a more hawkish US policy towards Iran and a freer US approach towards Israel. So I think Israel will have more leeway over the next several months. And then, of course, I do think we're going to see a continuation of strategic decoupling in the great power context. Again, as Juhi said, there's a continuation there. I think that is the remaining bipartisan issue in Washington: being tough on China. It'll look different. There'll be different tools. But I think that'll end up in the same direction at least. And so a lot more transactional activity on the foreign policy side, a lot more policy volatility. And so, you know, we'll see how that plays out. But I think this transactional approach is a significant departure from the last four years. But let's finish here. We can't have a discussion about the impacts here without ending on the Fed. And we've touched upon all of the key macro variables, but I'd like your respective views on where Fed policy goes in a Trump 2.0. How are you thinking about this, Juhi?
JUHI DHAWAN: The Federal Reserve has set out a path of easing, which really was based on growth and inflation without really knowing who the new administration would be and what their policies are going to look like. Once these policies are enacted, I believe the Federal Reserve will offer us fresh guidance. I think that they are faced, as we talked about, with a tougher trade off, should tariffs come into being, between its adverse potential impact on growth but also a higher inflation path. My personal thinking here is that the Federal Reserve's willingness to accommodate prior tariffs came about at a time when the inflation rate was lower. And they are a mandate driven central bank, so I would expect some reworking of their guidance once there's clarity on the policy agenda of the Trump administration. Maybe I would mention two other things worth keeping in mind when thinking about the Fed. One is that the central bank at some point will also end its quantitative tightening path. And will give us guidance on how it wants to reinvest its proceeds in the future. If they would like to change the composition of the proceeds in terms of where they reinvest them on the Treasury curve, this can have an impact on bond yields. So something to keep in mind as we think about it. And then the final thing I would mention about the Federal Reserve in this context is just to remind us that, Chair Powell’s term will be up and this will be a nomination that President Trump will make in his term. But also important to keep in mind whether ideas such as auditing the Fed come back to the forefront under the second Trump administration. Because this would be a change in how some of these institutional frameworks that we have taken for a long time as granted might start to shift.
THOMAS MUCHA: Mike, I'll give you the last word. Any thoughts on the Fed?
MICHAEL MEDEIROS: No, I think Juhi summed it up perfectly. I’d just say I think they have a bit of a dilemma, because, you know, credit where it's due: They've done an exceptional job. I think they had a big assist from the supply improvement in the economy. But, you know, they've been able to generate disinflation without the need for a significant output gap. Now, as Juhi said, the starting point on inflation is lower than it was a year ago, two years ago. But it's not back to target. And it's certainly not sustainably back to target. And so if you take the set of policies that we could be facing in the next 3 to 6 months, supply side constraints with the potential boost from fiscal policy, that's trickier for the Fed. Because on the one hand, they could focus more on the downside risk to growth at a time when inflation is rising further away from the target. And take a more dovish approach. And in this case, they would say tariffs are a one off price level shock. And it doesn't lead to sustained higher inflation. But they certainly risk inflation expectations becoming unanchored. And they've done an excellent job at keeping inflation expectations anchored over the last few years. Conversely, if they respond hawkishly and guard against those risks around inflation, then they could suffer more significant downside growth risks and probably be blamed for doing so, if the economy were to go into a recession. And so it's a difficult balancing act for them. But I think as they've done over the last year, they'll watch the data and they'll respond to that as best they can.
THOMAS MUCHA: So we've covered a lot of ground here. I think the one thing that we can all agree on is that the three of us are going to be very busy over the next four years trying to figure this stuff out. So I'm going to ask you both to come back repeatedly on WellSaid. But thank you very much for your time, Juhi Dhawan, Mike Medeiros, macro strategists for being with us on WellSaid.
MICHAEL MEDEIROS: Thank so much.
JUHI DHAWAN: Thank you.
Views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk. Podcast produced November 2024.
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