The economic challenges and uncertainties of Trump's victory

The market's reaction to the Republican victory suggests that Trump will ensure faster growth in the US, but public accounts are a threat

Donald Trump's victory in the US presidential elections and the Republican Party's regaining control of the Senate, while also coming close to winning the House of Representatives, pushed US stock indices to all-time highs on the back of expectations of new fiscal stimuli, also strengthening the dollar. However, the European and Chinese stock markets retreated, fearing Trump's protectionist policies. US Treasury Bonds were also penalized, with investors fearing a worsening budget deficit and a new inflationary impulse, caused by rising prices for goods and services dictated by protectionism.

The market reaction to the Republican victory suggests that Trump will ensure faster growth in the US, while the rest of the world will struggle to keep up. However, the optimistic scenario could be threatened by public accounts. In fiscal year 2024, the budget deficit reached 6.3%, and a tax cut could further exacerbate the negative balance by keeping long-term interest rates high, especially US sovereign bond yields, representing a major drag on growth. The yield on the 10-year US Treasury is currently almost 4.5%, while in 2016 it was only 2%.

To paraphrase Frédéric Bastiat, "there is what you see and what you don't see”. Looking back to Trump's first term in office (2017-2020), details that go unnoticed today could be crucial in anticipating the economic evolution of the three major blocs - the US, Europe and China - in the coming years. Mark Twain said that "history never repeats itself, but it often rhymes”, and this perspective is relevant. During that period, despite protectionist rhetoric and additional tariffs, globalization did not reverse, as evidenced by data from the "CPB World Trade Monitor”, which shows setbacks in international trade only in periods of recession. The weight of US trade in its nominal GDP remained at 26% from 2017 to 2020 and trade deficits at 3% of GDP, showing 'normal' and non-isolationist economic interaction. It is worth remembering that the world's leading companies are American, with global ramifications and interests.

Many fear that total Republican control of the administration and Congress would be harmful. In 2016, Trump had an inexperienced team, but today it is more robust and professional. In addition, the Republican Party and US democracy have checks and balances capable of preventing irresponsible economic policies. And despite a possibly more capable team, negative budget balances are higher, narrowing the margin for even more expansionary policies.

In November 2016, the public debt ratio was 104% of nominal GDP, while today it is 122%, and the budget deficit has risen from 3.1% to 6.3%. In addition, the US has never been more dependent on external financing than it is now. Net savings by households, companies and the government have been negative since the first quarter of 2023, something unheard of in more than 75 years, with the exception of the Great Recession of 2008/2009 and the second quarter of 2020. This situation has been offset by the increase in net savings by foreign investors with income in dollars and the appreciation of US net worth, driven by the artificial intelligence boom.

In the face of growing trade deficits, it is likely that dollars earned by foreigners will continue to be invested in US assets, but stocks need to continue to appreciate to attract investors. However, the S&P 500 has already appreciated 40% in the last 12 months.

As for Treasury Bonds, the question is what premium foreigners will demand to compensate for the risk of a potentially hostile government and unbalanced public accounts. A 10-year yield above 5% could lead to recession. However, a country dependent on foreign funding cannot afford to have a government that is hostile to investors.

The Republican Party and US democracy have checks and balances capable of preventing irresponsible economic policies

PAULO MONTEIRO ROSA
Professor and senior economist at Banco Carregosa