As the U.S. presidential election draws near, the term Trump Trade is resurfacing in financial circles. Despite various controversies, the market seems to be leaning toward a Trump victory, as reflected in investor sentiment and polling data. While there are concerns about manipulation—such as the suspicions raised by The Wall Street Journal—investors seem reluctant to shift away from the Trump Trade. If this were merely a temporary distortion, the market would have adjusted swiftly. While it's still early to predict the outcome with certainty, the market sentiment appears to favor Trump.
What Is the Trump Trade?
The Trump Trade is essentially a market strategy that anticipates the impact of Trump’s policies on the financial markets. It became popular during his presidency and is now making a comeback as the 2024 election approaches. For example, back in mid-July, the U.S. 10-year Treasury yield, which was close to dropping below 4%, suddenly surged to 4.2-4.3%. This jump can be seen as a market reaction to Trump’s potential economic policies.
Trump’s economic agenda focuses on tax cuts, specifically the corporate tax rate, which he plans to reduce from 21% to 15%. This proposal is reminiscent of the 2017 corporate tax cuts that spurred significant stock market growth, as companies had more cash to distribute through dividends and stock buybacks. Stock buybacks, in particular, help stabilize the market by reducing volatility and cushioning downturns.
However, this time around, the economic landscape is different. Back in 2017, the U.S. federal deficit wasn’t as severe, and inflation wasn’t a pressing concern. In fact, there were worries about deflation at the time. Now, inflation is a major issue, and lowering corporate taxes could further strain the government's finances.
The Trade-Off: Tax Cuts and Tariffs
Trump’s corporate tax cuts would likely worsen the U.S. budget deficit, and he has suggested tariff hikes to offset the shortfall in revenue. He has floated the idea of increasing general tariffs by 10-20%, and tariffs on Chinese imports could rise to 60-100%. While lowering corporate taxes boosts companies, tariffs have the opposite effect on consumers.
Tariffs lead to higher import prices, which trickle down to consumers as inflation. In 2018, during the U.S.-China trade war, the U.S. imposed a 20% tariff on Chinese goods, and China retaliated with a 22% tariff on U.S. goods. This mutual tariff escalation raised prices for consumers in both countries, and the same scenario could happen again. Higher tariffs not only increase inflation but also lead to higher long-term interest rates, as the Federal Reserve would need to counteract inflationary pressures.
The Inflation and Debt Spiral
The issue with Trump’s proposed policies is that they could lead to an inflation-debt spiral. If the U.S. doesn’t impose higher tariffs, the federal budget deficit would balloon due to lower corporate taxes. To cover the deficit, the government would need to issue more debt. Increased debt issuance means more supply of U.S. Treasuries, which would drive bond prices down and interest rates up. In this scenario, interest rates would rise regardless—either through inflation from higher tariffs or through increased debt issuance.
This creates a dilemma: lower corporate taxes stimulate the stock market, but the inflationary pressures from tariffs and debt lead to higher interest rates, which can hurt the broader economy. It’s a difficult balance to maintain, and the market is trying to navigate this uncertainty.
Immigration Policy and Wage Pressures
Trump’s stance on immigration also plays a crucial role in the Trump Trade. He has made it clear that he plans to restrict illegal immigration and reinforce the border, which would have significant effects on labor markets, especially in Mexico and Latin America. The Mexican peso has already reacted, with the exchange rate surpassing 20 pesos per dollar, a significant jump from its early-year low of 17 pesos.
Restricting immigration could lead to labor shortages in the U.S., particularly in sectors that rely on migrant workers. This would push wages higher, which could, in turn, fuel wage-driven inflation. Immigration has historically helped keep U.S. wage growth in check, and reducing the labor supply could increase pressure on wages, creating yet another source of inflation.
The Catch-22 of Trump’s Economic Policies
Trump’s economic policies present a complex set of challenges. His corporate tax cuts could boost the stock market, making U.S. equities more attractive to investors. As companies benefit from reduced taxes, they could engage in more share buybacks, which stabilize the market and support higher asset prices. This, in turn, could encourage U.S. consumer spending, which is a key driver of economic growth.
However, there’s a flip side. Tariff hikes and immigration restrictions could lead to higher inflation, while increasing the federal deficit would push the government to issue more debt, driving up interest rates. As inflation rises, the Federal Reserve may be forced to hike rates further, and the cost of servicing the national debt could soar, creating more financial strain. The Trump administration’s preference for a weaker dollar complicates this further. While a strong dollar helps to curb inflation by lowering import prices, Trump has historically favored a weak dollar to boost exports, which could exacerbate inflation.
Trump and the Federal Reserve: A Battle Over Rates
One of the defining features of the Trump Trade is Trump’s tension with the Federal Reserve. He has frequently criticized the Fed, pushing for lower interest rates to support economic growth. If Trump wins the election, it’s likely that he will continue to pressure the Fed for rate cuts. While this could lead to lower short-term interest rates, the long-term rates might continue to rise due to inflationary concerns. Currently, the 2-year Treasury yield has climbed above 4%, while the 10-year Treasury yield is nearing 4.2%. This disconnect between short- and long-term rates suggests that the market is pricing in higher inflation risks under a potential Trump administration.
Conclusion: The Complex Dynamics of the Trump Trade
The Trump Trade is a multifaceted market strategy that reflects the potential economic impacts of Trump’s policies. While his corporate tax cuts might temporarily boost the stock market, the accompanying risks of inflation, higher interest rates, and rising debt pose significant challenges. Add to that the uncertainties surrounding immigration and tariff policy, and it becomes clear that navigating the Trump Trade requires a careful balancing act.
As the U.S. presidential election approaches, the financial markets will be closely watching how these policy discussions evolve. The outcome of the election could have far-reaching implications for stocks, bonds, and inflation, and investors will need to remain nimble to adjust to the rapidly shifting landscape.