Author: Howard Schneider
WASHINGTON (Reuters) – U.S. President-elect Donald Trump campaigned on promises of aggressive import tariffs, tough immigration restrictions, deregulation and smaller government, but the economy he will inherit next week may be screaming for something different.
Namely, don’t break anything.
With output increasing above trend, the labor market near maximum employment and job creation, and the embers of inflation still simmering, Trump may be launching his promised reforms into an economy less in need of the stimulus provided by his 2017 tax cuts. stocks sold off after last week’s strong December jobs report, could also be prone to a correction given high asset values and a bond market pushing up yields.
“The Trump administration’s success would be to do no harm to the extremely successful economy it inherited,” said Mark Zandi, chief economist at Moody’s (NYSE: ) Analytics. On their face, the planned combination of tariffs, deportations and deficit-financed tax cuts “will hurt. How much … depends on how aggressively those policies are implemented.”
Trump will take office next week under far different economic circumstances than when he began his first four-year term in 2017.
“The constraints are different, starting with inflation,” which is not yet fully under control because of a pandemic-era spike and has shown little year-over-year improvement in recent months, said Karen Dynan, a Harvard University economics professor and former Obama administration official. Trump also faces a larger federal deficit and higher government borrowing costs than before, and a labor force that has grown faster than expected due to immigration, which Trump wants to curb.
Referring to recent U.S. results that outpaced those of other developed countries and surprised many economists, Dynan said that “if you believe that economic growth that exceeds the trend is the result of immigration, it will be difficult to get the numbers that we saw in the second part of the Biden administration .”
NEW LANDSCAPE
When Trump first entered the White House in 2017, the economy had grown steadily since the end of the 2007-2009 financial crisis, but the pace was often slow and employment had not fully recovered. There was room for the stimulus Trump signed into the Tax Cuts and Jobs Act, and while the import tariffs that followed dealt a blow to the global economy, the US proved largely resilient.
The longest US economic expansion in modern times ended only when the COVID-19 pandemic began in March 2020.
Inflation was a distant concern then, seemingly anchored below the Federal Reserve’s 2% target. Home buyers could find 30-year mortgages with a fixed rate of around 4%, and the government financed its operations with long-term government bond rates of around 3%.
Today, inflation is barely above the Federal Reserve’s target, mortgage rates are approaching 7%, and 30-year Treasury yields are around 5% and rising, a fact that may reflect market doubts about whether inflation is contained and whether financial discipline will in the US to move forward.
“There’s still concern that inflation may not be beaten … We’re going to fix that problem, so don’t worry about it,” Fed Governor Christopher Waller said last week of rising long-term bond yields. But “the other thing that’s getting more and more attention is the concern about fiscal deficits. . . . If that doesn’t change going forward, at some point the markets will demand a premium. . . . That’s starting to be what we’re seeing.”
Although Trump created an informal Department of Government Efficiency to find savings, there is no plan to address the main drivers of the deficit: health and pension benefits for the elderly that both political parties hold sacred.
‘VERY, VERY GOOD’
If government borrowing costs and bond market wariness represent one potential set of constraints for Trump, the state of the economy could represent another.
The headline data tracked by Fed staff and officials, including numbers on employment, inflation, consumer spending and overall growth, may not offer much room for improvement without risk.
The unemployment rate in December was 4.1%, for example, near or below many estimates of what is considered sustainable without generating inflation, and the economy gained an impressive 256,000 jobs. With wages rising, consumer spending remains healthy. Inflation is falling but is still more than half a percentage point above target, with concerns that it could reignite with any aggressive move to boost output that is already above potential or additional costs such as tariffs.
“The U.S. economy is performing very, very well,” Fed Chairman Jerome Powell said at a Dec. 18 news conference at the end of the central bank’s latest policy meeting. “However, we have to stay on task,” with monetary policy remaining tight enough to bring inflation back to 2% while keeping the labor market intact.
Between Trump’s plans and the strength of the economy, there is growing doubt about whether the Fed will be able to cut rates further, if at all.
The uncertainty about what lies ahead is rooted in the gap between Trump’s expansive rhetoric about what he seems to think the economy needs and actual economic performance over the past year.
Last month’s Fed meeting saw staff begin to suggest that slower growth and higher unemployment could be the immediate result of expected trade and other policies. Policymakers have publicly highlighted the uncertainty they face while trying to strike a balance.
Noting that businesses themselves were upbeat about conditions ahead, despite potential disruption from tariffs and deportations, “I expect more upside than downside in terms of growth,” Richmond Fed President Tom Barkin said last week, although he also acknowledged possible inflation risks.
And, Barkin said of the future administration’s likely policy initiatives, “you could roll back some of them if they turn out to be harmful.”
