Addressing The Elephant in The Room

Between March 2022 and July 2023, the Federal Reserve raised interest rates 11 times to combat inflation, which peaked at a historic high of 9.1% in June 2022. These measures were essential to temper demand by increasing borrowing costs, thereby curbing corporate and consumer spending to prevent inflation from spiraling further out of control.

By mid-2024, expectations of rate cuts grew as inflation appeared to stabilize, steadily moving toward the Fed’s 2% target. After maintaining interest rates at a peak of 5.5% for 13 consecutive months, the Fed initiated three rate reductions in 2024, starting on September 18, bringing rates down to 4.5%, aligning with market expectations.

However, policymakers now foresee only two rate cuts in 2025, totaling 50 basis points—half the initially projected 100 basis points. This shift reflects renewed short-term inflationary pressures, influenced by significant policy changes anticipated under the Trump administration.

Tariff Changes:?The trade war between China and the United States is expected to intensify, potentially reaching new levels. Reviving this conflict was a key agenda item in Trump’s 2024 presidential campaign, resonating with both ordinary citizens and corporate leaders. This focus stems from concerns over China’s growing dominance in the global economy and policies that disadvantage foreign companies like Starbucks and General Motors, making it difficult for them to compete with local or state-owned enterprises.

While addressing the trade deficit may not be a priority given it is a small fraction of US government annual revenue, the Trump administration is expected to emphasize bringing manufacturing jobs back to the U.S. and protecting technological intellectual property to maintain global leadership. If tariffs on goods imported from China and other countries are significantly increased, it could lead to short-term inflationary pressures, as higher import costs would likely be passed on to consumers and businesses.

Immigration:?Nationalist sentiments are on the rise globally, increasingly shaping political agendas in developed countries such as the United States, the United Kingdom, Australia, and Canada. During the 2024 U.S. presidential election, Trump emphasized mass deportation of immigrants, citing the need to preserve jobs for local workers and reduce crime.

However, long-term demographic trends in the U.S., including declining fertility rates and an aging population, highlight the critical role of immigrants in driving economic growth. Immigrants make significant contributions to the labor force, and policies that substantially restrict immigration could adversely impact the macroeconomic landscape by increasing labor costs, reducing productivity, and dampening overall consumption.

Tax Cuts:?Tax cuts consistently spark intense debate, with opinions divided almost equally between supporters and opponents. However, the core impact is clear: reducing individual tax rates increases disposable income, boosts consumption, and drives GDP growth, albeit at the cost of reduced federal revenue.

Tax cuts have significant potential to stimulate demand by encouraging consumer spending, attracting new investments, and creating jobs. However, two critical downsides must be carefully managed to maintain macroeconomic balance:

1. Inflation Risk:?Higher consumption and job creation could drive inflation upward.

2. Fiscal Deficit:?Reduced federal revenue could widen the fiscal deficit, potentially leading to higher sovereign debt or the introduction of indirect taxes and tariffs, which would ultimately burden consumers.

Source: Statista Research Department,?The Wall? Street Journal, Federal Reserve, Magtzer In, Investopedia, www.brookings.edu