Donald Trump won the US election and his Republican Party are one step away from a full sweep, with a formal confirmation on the House of Representatives election still pending. This ‘Trump sweep’ should lead to higher growth, higher inflation, and higher rates, supporting the USD in the short term, while concerns over US debt could become a longer-term headwind.
US election: Closing in on a Republican sweep
Six days after the US elections, the race had a much clearer end than anticipated, with Trump winning back all important swing states (Pennsylvania, Georgia, Michigan, Arizona, Wisconsin, and Nevada), obtaining 312 of the 538 electoral votes, and winning the popular vote by a margin of over three million.
The Republicans also secured a majority in the Senate, winning a commanding 53 of 100 seats (one result in Pennsylvania is still pending). The Republican sweep cannot be called complete yet, as results from 16 voting districts in the House of Representatives election are still pending. The Republicans hold a lead with 214 seats, only four shy of the 218 required for a majority. Preliminary results in districts still counting show the Republicans leading in six, making the confirmation of a Republican sweep only a formal exercise.
The Trump sweep will be growth-supportive through an expansionary fiscal policy, with support of Congress for a prolongation of the 2017 temporary tax cuts and potential further tax cuts. Hence, we revised up our GDP growth forecast last week to an average of 2.5% in 2025 and 2.5% in 2026, which is above the potential US growth rate of 2.1%. This should lead to rising inflation, which is why we raise our CPI forecast to 3.4% for 2025 and 2.7% for 2026. Thus, the Fed will likely cut interest rates more gradually, lowering the federal funds target rate by less to 4.25%–4.00% by 2025. Furthermore, US Treasury yields are set to rise to compensate for higher inflation and growth, supporting the USD in the short term. In the longer term, however, investors may demand higher risk compensation, which depreciates the USD, if concerns about US government debt increase.
US Fed: Shrinking room for rate cuts
The Fed cut rates again last week, just one day after Trump’s re-election, which is changing our outlook for further rate cuts. The prospect of looser fiscal policy under a Trump presidency reduces the Fed’s scope for rate cuts in 2025. With Trump’s Republican Party having won a majority in the Senate and likely to secure a majority also in the House of Representatives, extensions of the 2017 tax cuts and corporate tax cuts are now highly likely and have the potential to boost US growth in the coming years. US growth would then exceed the speed limit set by the potential growth rate, and excessive demand growth would put upward pressure on inflation, reducing the Federal Open Market Committee’s (FOMC) scope for further rate cuts.
We expect two more 25bps rate cuts from the Fed. Last week, the FOMC already slowed the pace of rate cuts from the bold 50bps cut in September to 25bps. The accompanying statement was slightly more hawkish, with the emphasis remaining on easing labour market conditions and the FOMC’s intention to avoid further deterioration in labour market conditions.
The progress of inflation towards the Fed’s 2% target remains the central expectation of the FOMC, as no concrete policy changes of the new administration are yet known and are therefore not reflected in the statement. We expect this to change as more clarity emerges about the new direction of fiscal policy and its potential to slow the progress of inflation towards the Fed’s 2% target. We expect the Fed to reduce the range of the federal funds target rate to 4.25%–4.00% by March 2025 and leave policy rates in slightly restrictive territory thereafter.
What does this mean for investors?
After putting the highest single probability on a Trump sweep at 45%, we always said this would imply higher growth, inflation, and rates should it materialise. So, we have now upgraded them all. We expect growth to rise to 2.5% in 2025/2026 vs 2.1% previously. Inflation could reach 4% against the pumping up of the economy. Even if bond investors do not riot, we expect US bond yields to rise to 4.75% by the end of 2025 at least. Yet we keep the USD forecast unchanged, as the currency will likely work as a valve if investor confidence in the ‘US miracle on Main Street’ wanes.
This is a pretty different picture to all other outcomes in the election that would have meant ‘more of the same’. Hence, it also calls for changes in terms of recommendations. In bond markets, we upgraded US high-yield bonds, as higher nominal growth bodes well for highly indebted corporates meeting their obligations going forward. The upgrade goes at the expense of some emerging market sovereigns, not corporates. In equities, we upgraded financials, with a strong preference for US banks and asset managers, which will likely get an extra boost from deregulation by the new administration.