The “Trump effect” on the world economy

Trump's victory, with a Republican majority in both houses, anticipates that, in the coming years, we will experience a more volatile stage in terms of legislative, economic, domestic, and foreign policy.

In the financial markets, stock market indices reacted positively to the decrease in electoral uncertainty and a foreseeable cyclically favorable fiscal and commercial environment for the U.S. The VIX volatility index fell by more than five points to 15.6, while (European) stock markets recorded general gains and future stock markets rose by more than 2% in response to this risk on mood discussed at the beginning of this press release. In fixed income, U.S. bonds increased yields reflecting not only possible expansionary fiscal policies (corporate tax cuts) but also a foreseeable higher inflation given the promised tariff imposition against China and the rest of the world.

As a result, with higher rate differentials, the dollar has risen to 1.07, although it is expected to correct and relax again to levels close to the average of the last month.
“Although still very preliminary, there is a return on portfolio flows to the U.S. as a result of all of the above, which will affect both European and emerging portfolios. Intensity will depend on what is actually implemented by the American economic, commercial, external and domestic policy,” explained MAPFRE Economics experts.

“In the short-term, the result will bring volatility to European equity, particularly in sectors strongly exposed to U.S. markets, such as luxury goods, technology, and automobiles, as tariffs and a strong dollar would affect profit margins. In the longer term, Trump's policies, including more tariffs and corporate tax cuts, and the effects of his foreign policy (higher defense costs for Europe) could have permanent effects on the European industrial sector with consequences that are difficult to assess,” they add.

MAPFRE Economic Research has thoroughly analyzed the consequences of the election results from the perspective of various policies: fiscal and monetary, trade, immigration and labor market, energy policy, and foreign policy.

Fiscal and monetary policy

With the victory of Trump and a Republican majority in both houses, his administration plans to extend the tax cuts in the 2017 Tax Cuts and Jobs Act to boost economic growth. His approach includes further reducing corporate tax to 15% and repealing taxes from the Inflation Reduction Act (IRA) to encourage investment and job creation. However, it does not necessarily align with energy transition goals and leaves unresolved issues around foreign (European) investment decisions stemming from this shift, as well as U.S. investment in its North American trade partners (Mexico and Canada).

“In the short-term, Trump's tax cuts are likely to drive business investment, job creation, and consumption, leading to faster economic growth. However, in the long term, these cuts could increase the federal deficit and national debt, potentially raising debt costs and limiting future fiscal options,” says MAPFRE Economics.

Commercial policy

In economic terms, and according to MAPFRE Economic Research Service, the most likely scenario involves a 60% tariff on China and rates between 10% and 20% on other countries. While this may benefit the U.S. in the short term, international trade theory consistently indicates that, in the long run, it would be detrimental for both the U.S. and the global economy by reducing trade, slowing global activity, and increasing inflationary pressure on imports. The consensus is that in the long term these measures may cost between 20 and 60 basis points of GDP. “This measure will also certainly lead to the retaliation of the countries affected,” they explain.

As for Federal Reserve, “it would be hard to believe that it could make major changes without a broad consensus in Congress and the Senate. But interference similar to that experienced in the past is expected,” they conclude.

Immigration and labor market policy

Trump's immigration policy, based on a strict approach to border security, will probably “focus on reducing illegal immigration and deporting undocumented immigrants involved in criminal activities,” says MAPFRE Economics. This approach could include greater resources for border security, stricter visa restrictions, and limited channels of refuge.

Although mass deportations are unlikely, a focused policy could significantly reduce the availability of immigrant labor in sectors such as agriculture, construction, and services, where undocumented workers currently represent a significant part of the workforce. This will lead to greater tension in the labor market with consequences on supply, growth potential, and inflation, which will also increase.

Energy policy

Under the Trump administration, energy policy will likely largely focus on expanding fossil fuel production, prioritizing energy independence over environmental regulations. Key measures would include increasing the leasing of federal land for oil and gas drilling, eliminating pollution restrictions, and reducing subsidies for renewable energy introduced by the Inflation Reduction Act (IRA). By streamlining environmental approvals, the administration seeks to stimulate immediate growth in the energy sector, create jobs, and reduce domestic energy prices. However, this approach could reduce the competitiveness of the U.S. in the long-term global clean energy market, as investments move toward traditional energy sources.

Foreign policy

Under the new Trump administration, the U.S. will probably adopt a more unilateral approach to foreign policy, with less participation in multilateral organizations such as the United Nations, NATO, and the World Trade Organization. Trump has constantly criticized these organizations for what he perceives as an unfair dependence on U.S. resources and has defended a “America First” stance. His administration could put pressure on allies to increase their contributions to collective defense, especially within NATO (see note “The Worst of Scenarios”), and even reconsider U.S. commitments if other countries fail to meet these demands.

With regard to the war in Ukraine, the Trump administration would probably adopt a more cautious and limited approach in terms of U.S. participation. Trump has previously expressed his reluctance to provide extensive military aid, suggesting a focus on diplomacy instead of direct commitment. Under this approach, the administration could reduce or condition support for Ukraine, encouraging European allies to play a leading role in the conflict. This change could affect the cohesion of NATO's stance in Ukraine, potentially encouraging Russia and leading to a readjustment of security dynamics in Europe. Trump's approach would probably focus on minimizing U.S. financial and military obligations while emphasizing the need for European nations to assume a greater burden.

In the context of the ongoing conflict in Israel, the Trump administration would probably reaffirm its strong support for Israel, as seen during its previous mandate. This could include continued military aid and strong diplomatic support, especially in the face of regional threats. The Trump administration could also push for additional measures to counteract the influence of adversaries such as Iran, which would potentially increase sanctions and pressure to limit its support to hostile groups towards Israel. Trump's close alignment with Israel's security interests could lead to growing tensions with other regional players, which could complicate U.S. relations with countries seeking a more balanced approach in the Middle East in terms of geopolitics. Furthermore, it is to be expected that there will be a push toward a negotiation in the Ukraine conflict that will allow peace to be restored, as Trump does not share the motivations implicit in this proxy war with Russia that the previous administration had.

Assessment

In general, markets and the world celebrate the end of uncertainty and apparently more pro-market policies. However, an internal and external evaluation period is now underway, during which investors, citizens, and other countries are assessing the implications at all levels. For this reason, it is advisable to also consider the longer-term effects.

In the medium-term, however, the Trump administration points to nationalist policies that offer privileges to the domestic economy and reduce international commitments, generating uncertainty in the markets and possible long-term tensions in the economy and international relations. The most obvious will be the upturn in inflation, with the possibility of turning it into structural, an increase in fiscal unsustainability, and a trade fracture with direct effects on the rest of the world. In the long run, there will be other indirect effects on the U.S., which will face a world with lower long-term growth capacity, higher inflation, and some imbalances.

Trump's victory, and the maintenance of the majority in congress will facilitate the governance task according to his program.

The economic and financial policies of a country are a long-term task, especially their impacts, but it is expected that the 47th president of the U.S. will begin implementing the measures of their program as soon as possible.

It is expected, as stated in his speeches and interviews, that Trump or Congress will promote a review of the leadership, responsibilities, and obligations of the intelligence and security agencies to the democratically elected authorities, Congress and Senate, especially considering they have been politically weaponized against him.

As for Federal Reserve, it would be hard to believe that it could make major changes without a broad consensus in Congress and the Senate.