Finally, the election is over. For many months over the past year, investors parsed inflation reports, employment reports, and even formerly exotic reports such as the Senior Loan Officer Opinion Survey to better understand the economy’s trajectory. While these reports were important, they masked the key event that hovered over markets for the past year: the outcome of the presidential and congressional elections and the implications of that outcome for economic policy. Former President Donald Trump’s decisive electoral victory and the Republicans’ reclaiming of Senate and House majority control present us with a clearer handle of how economic policy may soon unfold. What follows are our thoughts on what that unfolding has in store for the economy and markets.

Economy

On balance, the election results should be positive for economic growth in the U.S. over the near term. Key provisions of 2017’s Tax Cuts and Jobs Act are likely to be made permanent next year, which would result in no increases to personal or corporate tax rates. In fact, corporate tax rates appear likely to move lower, from 21% to 20% for most companies and from 21% to 15% for domestic manufacturers. A clearer view of tax policy—which suggests that personal tax rates should remain unchanged and that corporate taxes may move lower—should add fuel to the economy’s recent strength. In addition, the Trump administration has declared its intention to loosen economic regulations and to streamline the regulatory process. The potential for regulatory reform, including the establishment of a so-called regulatory clearinghouse that would allow companies to seek multiple agency permits from one entity, would further support economic growth in the years ahead.¹

Potentially offsetting those stimulative measures will be the imposition of additional tariffs on imported goods. The extent to which tariff costs are born by consumers via higher prices or corporations via lower margins remains to be seen. Some of the financial commentariat has honed in on the former dynamic and the risk that new tariffs will result in higher prices of consumer goods. In this view, additional tariffs are seen as intrinsically inflationary. While we agree that some companies may pass through tariff-related costs to end consumers, we expect more companies to forgo increasing prices and to accept lower profit margins as a result.² Thus, we do not view the potential imposition of additional tariffs as a primary source of inflation risk.

Elevated inflation risk rather stems from likely changes in immigration policy and deficit-fueled fiscal stimulus. Over the past three-and-a-half years, a wave of immigration into the U.S. has helped grow the labor force—growth that has added slack to the labor market and slowed wage growth.³ A reversal of this wave could reverse this dynamic, resulting in a lower unemployment rate and accelerated wage growth. The latter development, of course, would be positive for U.S. workers. On the other hand, accelerated wage growth could also drive consumer demand and prices higher, resulting in renewed inflation anxiety.

Not only could tighter labor markets drive inflation expectations higher: a large, persistent, and growing federal deficit—which for the fiscal year of 2024 amounted to $1.8T or 6.5% of GDP—could also fuel inflation expectations.⁴ Federal budget deficits, of course, are not new. Yet those deficits continue to feed a debt pile that is now approaching the level of U.S. GDP.⁵ Should the new administration and Congress convey willingness to accelerate this trajectory—without offering plausible plans for reducing federal debt in the future—investors might surmise that the U.S. will ultimately allow inflation to run high to reduce the value of its debt.

Markets

Despite these warranted inflation concerns, the direction of economic policy appears positive for U.S. corporations, and thus U.S. equities and corporate bonds. Markets clearly agree and are following the 2016 post-election playbook. Unlike 2016, however, markets were generally positioned for this electoral outcome in the weeks leading up to the election—and the prospective economic policy changes to result. Thus, while the direction of market prices has followed the same trajectory as in the days following 2016’s election, the magnitude of those changes has been less dramatic.

Unlike equity markets, bond markets have not reacted so favorably to prospects of economic policy changes. Since the election, bond markets have fallen and 10-year Treasury bond yields have risen from 4.27% to 4.45%, despite the Federal Reserve lowering its target rate by another 0.25% on November 7th. As we noted in our recent Insights paper, rising long-term bond yields reflect both the investors’ expectations for future short-term rates and the excess return required for assuming inflation risk. Improved growth prospects from lower tax rates have moderated expectations for rate cuts next year, and potential disruptions to trade and immigration policy have helped raise inflation fears. Both factors have combined to push bond prices lower in recent weeks.

Goelzer’s View of Post-election Risks (& Opportunities)

Improved growth prospects, fueled by tax cuts and regulatory changes, are positive for corporate earnings and should support U.S. stock returns. We view small-and-mid cap U.S. stocks as most likely to benefit from these policy changes. Large-cap tech stocks stand to benefit if inflation anxieties increase and companies seek increased technological solutions to manage costs. Long-term bonds, however, could be challenged in such an environment, which would make alternatives, such as commodities and real estate, important sources of potential returns and portfolio diversification.

With meaningful changes on the horizon—both in policy and in communication of that policy—we expect market gyrations to pick up. As markets attempt to digest these changes, investors will be tempted to react now and think later. We prefer to think now and act intentionally when those gyrations create opportunity.

¹ For more on potential regulator changes, see Dan Goldbeck, “The Return of the Trump Deregulatory Regime,” American Action Forum, November 14, 2014, www.americanactionforum.org/insight/the-return-of-the-trump-deregulatory-regime/. See also Chris Low, et al. “What a Trump II Economy Might Bring,” FHN Financial, Economic Weekly, November 8, 2024.

² September’s edition of the U.S. Federal Reserve’s Beige Book, which collects observations on economic conditions from the Federal Reserve’s 12 economic districts, noted increasing price sensitivity among consumers. By extension, it would be reasonable to anticipate waning pricing power among businesses. For more information, see Amara Omeokwe, “Fed’s Beige Book Shows Little Growth Across Most of U.S.” Bloomberg. October 23, 2024.

³ From April 2023 through October 2024, the unemployment rate has risen from 3.4% to 4.1% and average hourly earnings growth has fallen from 4.7% to 4.0%. Bureau of Labor Statistics, as of October 31, 2024.

⁴ Chris Low, et al. “Deficits, Inflation, and Interest Rates,” FHN Financial, Economic Weekly, October 25, 2024.

⁵ For a more detailed argument for the relationship between fiscal deficits and inflation, see John Cochrane, “Fiscal Narratives for US Inflation,” January 29, 2024. static1.squarespace.com/static/5e6033a4ea02d801f37e15bb/t/65b8874edc9c1c030394d950/1706592078859/Sims_comment.pdf.

⁶ The percentage of publicly held federal debt to GDP, as of April 30, 2024, equals 95.2%. For the five-year period preceding the Covid-19 pandemic (from January 31, 2015 through January 31, 2020) the average level of publicly held federal debt to GDP was 75.8%. For the five years prior to the Great Financial Crisis (January 31, 2004 through January 31, 2008) the average level was 35.1%. White House Office of Management and Budget and Bloomberg.

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