Is Trump 2.0 Bullish Or Bearish?

Trump 2.0 I: Lots of Moving Parts. So far, it has been the Roaring 2020s for the US economy and US stock market. Real GDP is at a record high, and so is the S&P 500. That’s impressive considering that the global economy was hit by a pandemic at the start of the decade, there was a radical regime change from Trump 1.0 to the Biden administration in 2021, the Fed raised interest rates significantly from March 2022 through August 2024, and there have been two major geopolitical crises that remain unresolved. Oh, yes: There was also that widely anticipated recession that never happened.

The economy has been resilient. Will it remain so during Trump 2.0? That’s the #1 question that Eric and I have been fielding ever since Election Day resulted in a Republican sweep.

The naysayers continue to raise doubts about the resilience of the economy. Some of them concede that they were wrong about expecting a recession in response to the tightening of monetary policy over the past three years. However, they blame their error on fiscal policy, which they (now) correctly observe has been very stimulative but doubt it will be for long. (We’ve identified several additional reasons for the economy’s resilience over the past three years.)

Since the start of 2022 through October of this year, total federal government spending is up $192 billion (using the 12-month sum) to $6.9 trillion (Fig. 1). Government spending on Health, Medicare, and Social Security rose $623 billion to a record $3.3 trillion over this period. There was a big drop in government spending on income security by $806 billion to $0.7 trillion, but that was almost completely offset by a $139 billion increase in defense spending to a record $0.9 trillion and, even more significantly, by a $510 billion increase in net interest outlays to a record $0.9 trillion (Fig. 2).

Focus on those numbers for a minute. The decline in the government’s spending on pandemic-related income support after the contagion abated has been largely offset by the government’s outlays on net interest as the federal debt and interest rates have soared (Fig. 3). Most of those interest payments have boosted personal income. Since January 2022 through September of this year, personal interest income has soared by $432 billion to $1.94 trillion (Fig. 4). Over the same period, personal nonmortgage interest payments rose $278 billion to $0.6 trillion.

The bottom line is that federal government spending remains very stimulative, and so do government deficits. Government spending that is deficit financed rather than paid for with tax revenues is more stimulative than spending based on a pay-as-you-go budget rule.

In the past, the ratio of federal government spending to federal budget receipts tended to fall during economic expansions (Fig. 5). It tended to rise during recessions and recoveries. This time, the ratio rose from 1.2 during summer 2022 to 1.4 during October of this year even though there was no recession. In other words, fiscal policy, which was usually countercyclical during periods of economic growth, has been procyclical this time, stimulating a growing economy.

Now that President Donald Trump and his Republican Party have won a clean sweep on Election Day, the question is whether fiscal policy will remain stimulative or turn restrictive. Nondiscretionary spending (including net interest outlays) accounts for roughly 85% of total outlays (Fig. 6). It will certainly go up, and so will defense spending. The corporate tax rate is likely to be cut, and so are individual income taxes on tips, overtime, and Social Security. All of those tax cuts will widen the federal deficit. It’s possible that the Republicans will reduce some of the spending authorized by the so-called Inflation Reduction Act.

Notably, in Trump 2.0, fiscal policy isn’t just about government spending and tax revenues. It is also about revenues raised from higher tariffs, which might increase the risks of a global trade war. It is also about deregulation, which should be stimulative by lowering the costs of doing business. The administration’s goal of reducing the size and scope of the federal government will pare the government’s headcount, which could weigh on payroll employment. Deportation is another major policy issue that could reduce the labor force with inflationary consequences unless productivity offsets the resulting labor shortage. Last, but not least, is the question of whether Trump’s energy policies will boost oil and gas production, thus keeping a lid on their prices.

In other words, there are lots of moving parts in Trump 2.0. On balance, we expect that Trump 2.0 will boost productivity and economic growth, keep inflation subdued, shrink the size of the federal government, slow the growth of government spending, and narrow the federal deficit. On second thought, we don’t expect all that will happen, but we do believe it all has a good chance of happening, and we hope it mostly does. There’s certainly no shortage of “known unknowns” in the outlook under Trump 2.0. Nevertheless, our base case for the remainder of the decade, with Trump 2.0 running Washington over the next four years, remains the Roaring 2020s.

As we’ve often observed in the past, we are constantly amazed by how well the US economy has been able to perform despite Washington’s meddling.

Trump 2.0 II: Taxes, DOGE, Tariffs, the Fed & Bond Vigilantes. As noted above, there are lots of moving parts to Trump 2.0. Here are some of our more specific observations on this matter:

(1) Under Trump 1.0, the Tax Cut and Jobs Act (TCJA) included a sharp reduction in the corporate tax rate from 35% to 21% (Fig. 7). Individual income tax rates were also lowered. Most of the provisions of the act were implemented in 2018. Total federal government receipts were at $3.34 trillion during the 12 months through December 2017 and little changed at $3.33 trillion in 2018 before climbing to $3.50 trillion during 2019 (Fig. 8). The decline in corporate tax receipts during this period was more than offset by higher individual and payroll tax receipts.

Under Trump 2.0, most of the provisions of the TCJA, which are set to expire in 2025, are likely to be extended. In addition, the corporate tax rate is expected to be cut to 15%. Taxes on tips, overtime pay, and Social Security might also be cut.

(2) All these measures will bloat the federal deficit and risk inciting the Bond Vigilantes. Hopefully, Trump’s new team of economic advisors will alert the President to this prospect, much as President Bill Clinton’s advisors warned him about the need to placate the Bond Vigilantes. Clinton did so. Trump may be signaling that he gets it by appointing cabinet secretaries that are set to cut their departments’ budgets and headcounts rather than to bloat them. That could weigh on payroll employment, though federal government payrolls haven’t been a source of employment growth, holding steady around 3.0 million employees for many years.

Trump has also created the Department of Government Efficiency (DOGE), headed by Elon Musk and Vivek Ramaswamy. They have been tasked with reducing waste and fraud in the federal government. Previous presidents have attempted to do so without much success. The problem is that about 85% of the federal budget is for mandatory spending including Social Security, Medicare, health care, income security, national defense, and net interest outlays. That leaves about $1 trillion in nondiscretionary government spending. Nevertheless, rooting out waste and fraud in all categories of government spending could produce a significant reduction in overall spending.

(3) Trump also intends to impose a 10%-20% tariff on US imports to raise revenues. Under Trump 1.0, federal government revenues from customs duties doubled from about $40 billion in 2017 to almost $80 billion in 2019 (Fig. 9). A 10%-20% tariff on all US imports of goods and services would generate $400 billion to $800 billion in revenues (Fig. 10). That’s assuming that these higher tariffs don’t reduce imports significantly or start a global trade war.

(4) Finally, here’s a friendly word of caution to the President: If you beat up on Fed Chair Jerome Powell to lower the federal funds rate, the Bond Vigilantes will only get madder. At his last press conference on November 7, Powell once again stated that “fiscal policy is on an unsustainable path” and “the level of our debt relative to the economy is unsustainable.” He indicated that once the new administration provides enough information on fiscal policy, the Fed’s staff will “start to model it” and “estimate the likely effects on the economy.” It is certainly conceivable that the Fed’s economic model will signal that Trump 2.0 is likely to boost economic growth while increasing the risk of higher inflation.

The Bond Vigilantes haven’t needed a model to come to the same conclusion.?The 10-year Treasury bond yield has soared from 3.62% on September 18 to 4.41% on Friday. Of that 79bps increase, the TIPS yield rose 49bps and the inflation premium rose 30bps (Fig. 11 and Fig. 12).

Trump now needs to win over the Bond Vigilantes to make Trump 2.0 a success. He has proudly observed that the stock has been rising since he won the election on November 5 (Fig. 13). He should also watch the bond yield, which could impact the stock market’s valuation multiple. When he won his first term on November 8, 2016, the forward P/E of the S&P 500 was 16.0 (Fig. 14). Last week, it was 21.9. He should know that there is more downside than upside in the P/E over the next four years unless his policies win over the Bond Vigilantes.?

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