Executive Summary

Whoever wins the White House in November will be confronted with a changing US economy. While the US has remained remarkably resilient despite rising interest rates and global uncertainty, it has become more prone to inflation volatility, given a larger exposure to frequent supply shocks and structural labor shortages. Against this backdrop, demand-boosting policies (such as tax cuts) or supply-hurting policies (tariff hikes) could re-ignite inflation faster and push up interest rates. Social tensions and fiscal trade-offs also raise concerns about the future of fiscal policy. On the other hand, the roll-out of artificial intelligence (AI) is likely to boost productivity and GDP growth, and the US’s energy net-exporter status provide additional room to manœuvre.

In this report, we look at what the return of President Trump could mean for growth, inflation and capital markets, as well as trade, fiscal and industrial policies. So far, several of Trump’s campaign pledges have raised far-reaching questions especially for the transatlantic partnership: from the resolution of the war in Ukraine, to the US exiting (again) the Paris Accord, to an escalation of the US-China Cold War. Narrowing down on economic policy-making, we analyzed three fault lines: (i)  the return of trade war, with the alleged plan to increase tariff rates to 10% and unleash industrial subsidies to re-shore production in the US; (ii) the fiscal bazooka that could ensue after the elections, given the 2017-2019 playbook, and the return of dirigisme everywhere – in contrast with Biden’s promised fiscal cliff – and (iii) the conduct of a credible monetary policy. Given the many stagflationary risks (even a boom-bust pattern) stemming from increased protectionism, fiscal profligacy and interventionism, we expect a pragmatic policy approach, supported by a scenario of a divided Congress and Republican Party.

First, tariff increases are likely to be more moderate and targeted than pledged, though still substantial. We think record-high tariffs would hurt the US economy more than in 2018-19: President Trump’s pledge to crack down on trade diversion and tariff evasion would be inflationary. In our baseline scenario, we expect that Trump would increase the US effective average tariff rate from 2.5% currently to around 4.3% – i.e. not 10% but still the highest level since the mid-1970s – and crack down severely on tariff evasion. In addition, we estimate that the crackdown on tariff evasion through stepped-up customs checks at the borders would push up short-term inflation by +0.6pp by lengthening suppliers’ delivery times, although a stronger USD that we would expect could mitigate this effect.  Trump would likely recycle additional customs duties into industrial subsidies to support the economy. This scenario could knock off -0.5pp and -0.2pp from US and global economic growth in the first year, respectively. In our downside scenario (a near-full implementation of campaign pledges), the effective tariff could go up to 12%, the highest level since the early 1940s. In this case, the cost to US and global GDP would be much larger, at -1.4pp and -0.6pp, respectively. However, in both cases we would expect Trump to target goods that are not critical for the US economy, equivalent to 55% of imported Chinese goods and 70% of EU goods. China’s textiles sector and the US transportation equipment sector would be the hardest hit.

Second, the administration is likely to play it cautiously on fiscal policy. A Trump 2.0 presidency would inherit very large fiscal deficits from the Biden administration and rising interest expenses. Another round of large, deficit-financed tax cuts (or increased spending) could thus re-ignite inflation and heighten concerns about the sustainability of US public finances in bond markets. Besides, it is unlikely that fiscal hawks among the Republicans would sign off on large tax cuts or new spending, given the poor state of US public finances. Finally, the Trump administration may itself recognize that as long as public deficits remain large, it will be challenging to significantly reduce the trade deficit. In this context, we would expect the Trump administration to fund its fiscal pledges with increased customs receipts and the repealing of some of President Biden’s policies. Overall, the fiscal stance could be slightly loosened in the first year of a Trump presidency but turn neutral in the later years.

Also note that some of Biden’s green subsidies would likely be repealed and replaced; we would expect new broad-based subsidies for production and tax credits for investment. The subsidies are likely to be targeted towards technological sectors and supply-chain strengthening (esp. raw materials, rare earths), chemicals and minerals, but also steel and autos. Under a fiscally responsible Trump administration, we would expect non-green industrial subsidies to be boosted by around USD55bn per year (0.2% of GDP).

Last, against this backdrop, we would expect the Federal Reserve to be forced to pause its easing cycle in 2025 and the US 10-year yield to stay above 4%. Equity markets would likely undergo a downward adjustment due to the short-term impact of increased rates on valuations. A short-term spike in inflation would prompt the Fed to err on the side of caution. The policy rate and Treasury yields would remain above 4%, and equity markets would be hit. Though a significant market downturn is unlikely, risks will accumulate. More plausibly, markets may experience a period of lateral movement throughout 2025. Looking ahead to 2026 and 2027, policies favoring domestic priorities, along with an expected shift towards more accommodative monetary policy by the Fed, are likely to positively influence US corporations as a whole. This could lead to US markets outperforming international counterparts, with expected annual returns of 8-10%. On the FX market, the stretched valuation of the dollar suggests there would be limited scope for appreciation for the USD (+2.5%).