Donald Trump and Inflation

Millions of Americans have voted - the majority of them for Donald Trump. What could this mean for international capital markets?

Donald Trump has won the election for the US presidency - and not only that. In future, the Republicans will probably also hold the majorities in the Senate and House of Representatives. Six out of nine judges of the Supreme Court have also been appointed by Republican presidents (for life), including the presiding judge. Donald Trump alone has chosen three.

In a world of alternative facts and a public divided by the media, there has probably never been a president in US history with so much power, especially as there is virtually no opposition to Donald Trump within the Republican Party, no inner-party corrective. This is probably not good news for the world, especially not for Europe.

But what can investors expect from “Trump reloaded”? In his early victory speech last night, he announced what he intends to do in the coming years: end wars, secure borders, defeat inflation, repay debts and at the same time give a strong boost to US growth and create jobs. Almost as expected, he promised nothing less than a “golden age” for the United States. The question is, what can and what will become reality? There is an obvious conflict of objectives, at least in the triad of “repaying debt, cutting taxes and fighting inflation.”

Debt, debt, debt

This summer, the US government's debt broke through the 35trillion dollar mark. Excluding intergovernmental loans, the debt-to-GDP ratio is still a whopping 100 percent of gross domestic product (GDP). A huge burden for future generations, which is likely to increase further under current law and according to the projections of the Congressional Budget Office. According to these calculations, the US government's debt is expected to reach 125% of GDP by 2035. It is quite possible that this figure is just one stage on the way to even higher levels in the next ten years.

For Trump, this 125 percent is certainly not an upper limit. Whether it's tax breaks for overtime worked, increased spending on border security and the military or a possible reduction in corporate tax rates - there are no limits to his “ingenuity” in expanding the debt. And as a result, the national debt could even rise to 143% of GDP by 2035 under Trump, as an analysis by the Committee for a Responsible Federal Budget shows. Admittedly, such projections are subject to a high degree of uncertainty, as the authors of the study also write. However, the trend is clear: the US mountain of debt is likely to grow, rather than be reduced over the next few years.

Government spending and tariffs as drivers of inflation

Keeping debt affordable in the long term requires moderate, or even better, low interest rates. Debt-financed growth combined with moderate interest rates drives inflation in the long term, as do trade tariffs, which the Trump administration is expected to impose “to protect” the US economy. Inflation is a problem that Kamala Harris and the Democrats are likely to have “fallen on their faces” during the election and that Trump has promised to solve. It is quite possible that this promise will catch up with him at some point.

The US Federal Reserve (Fed) could face challenges because of a sustained high deficit in the US national budget. As part of its dual mandate, the Fed pursues two goals: full employment and an inflation target of two percent. While high government deficits are likely to have a positive impact on economic growth in the short term and therefore also on the employment situation, the inflationary implications are less encouraging. This is because if a deficit-induced increase in overall economic demand meets a supply of goods and services that cannot be expanded or can only be expanded slowly, the higher purchasing power will result in higher inflation rates.

The experiences of the pandemic years should therefore serve as a cautionary tale. At that time, generous government transfers to private households and companies in the US worth several trillion US dollars were met with a restricted supply of goods that suffered from supply chain problems. A key interest rate level of just under five percent is still evidence of this today.

Someone has to buy the government bonds

Ever-increasing government spending is not a risk-free undertaking. In the medium to long term, ever higher debt ratios increase the likelihood of a “Liz Truss moment”, in which the capital markets could withdraw their confidence from the US government.

Liz Truss, the former Prime Minister of the United Kingdom, felt the gravitational pull of the capital markets shortly after her inauguration in September 2022 and was to remain in office for less than two months. Her plans for tax cuts and higher borrowing resulted in rapidly rising gilt yields. They forced the government to abruptly change course and the British central bank to intervene in the billions to stabilize the financial markets.

The USA undoubtedly enjoys an extraordinarily high reputation on the international capital markets, meaning that events in the UK cannot simply be transferred to the USA. However, even a US president cannot push through his debt-financed plans without the support of the capital markets - after all, someone has to buy the debt or government bonds. In the end, the US Federal Reserve could step in.

Shareholders celebrating, bonds under pressure

From the perspective of the US stock markets, Donald Trump may have been the better choice, at least at first glance. Because while Kamala Harris has planned to raise corporate taxes from 21% to 28%, Trump intends to do the opposite: Corporate taxes are to fall to 15 percent for domestic producers. In this respect, the after-tax profits of US companies are likely to be higher under a Trump administration - and cause some shareholders to celebrate.

But things are not quite that simple. Trump's plans to raise import tariffs are not only poisoning the trade climate; they also have the potential to reverse the globalization gains of the past decades, at least in part. A scenario in which there are no winners.

That said, equities remain an important building block for long-term real wealth preservation - with or without Trump. In times when debt-related upside risks to inflation have increased, the tangible asset character of equities is even more important. With rising debt (and geopolitical risks), gold also retains its justification in a mixed portfolio. As a hedge against the risks in the financial and monetary system - even if Trump certainly meant something else with the term “golden age”.

Yields on US government bonds are rising today. Given the political signs for inflation and growth, this reaction is understandable. However, today's price movements also underline the fact that bonds should not be viewed as a risk-free asset class across the board but must be actively managed and used flexibly - in order to benefit from attractive current income and diversification potential in view of the increased yields.