US investment strategist: Trump agenda raises inflation risk

Forecast for US economy

George Bory: Over the entire year, that growth may slow down a little, maybe to about two and a half percent–so a modest slowdown in growth, but still above trend and still expanding, so growth is expected to be healthy.

Inflation is probably a more difficult question to answer. Inflation in the US has been coming down from the very high levels that we saw back in 2022 and into 2023. But core inflation has been coming down over the course of this year. The rate of change or the pace of the decline in inflation is starting to slow. And the big question that we ask ourselves, and that many people are asking us, is how will inflation unfold next year?

President-elect Trump has some major changes in policy that he would like to implement along with the Republican Party. Those changes may cause inflation to go a bit higher. So we think for next year, a combination of slightly slower growth and slightly higher inflation is a good base case for 2025.

Bory: When we say that the Fed is walking a tightrope, we mean they have to be very careful with policy. They are having a difficult time, like us and many participants in the market, projecting far in advance. Since policy has not changed yet, policy proposals are what’s expected. It’s very difficult to project too far in advance. The Fed started cutting rates in September, and they’ve continued to cut rates in 2024. We think it will take time in 2025. They will probably have to wait to see what type of policy is actually implemented. We think that the challenge with policy is not so much the policy itself but the timing.

If the US decides to increase tariffs, that can be done very quickly, within the first few months of the year. If the US wants to cut taxes, that takes much longer. So you may see tariffs go up first and then taxes come down later. The timing matters because the first could push up inflation before you see the benefits of growth.

Higher tariffs, immigration crackdown could fuel inflation

Bory: There are four components to Trump’s agenda. Helping capital formation is first and foremost.

Then there is reducing taxes, particularly income taxes on individuals. The US economy is driven by personal consumption, and so by reducing income tax, the expectation is that it will help boost growth.

At the same time, the broader Republican agenda is to deregulate or soften regulation in certain industries, finance and banking being one of those. Again, this helps improve capital formation, it tends to be positive for growth.

But on the flip side are two other components of policy. One is immigration–Trump would like to tighten immigration at a time when labor participation is fairly low. And reducing the amount of immigration into the US constrains the labor force. At the same time, wage growth is relatively high in the US. So this could have a dampening effect on growth.

And then lastly are tariffs, which are the most difficult to predict. As we’ve seen, Trump has already proposed or suggested adding tariffs to imports from Mexico, Canada and China as well. We believe that tariffs will go up, and that will be inflationary.

Bory: It’s possible, but it’s important to remember that Trump campaigned on the challenges of inflation. He emphasized the impact that high inflation has on individuals, on corporations and on the economy. So we believe that the Trump administration and the broader Republican Party would like to keep inflation as low as possible.

So there might be some upward pressure on inflation, but we do not think that it will be significant. We believe they’re very sensitive to the impact of inflation, and so there will be a meaningful amount of thought put into policy changes, with a very specific focus on how it impacts inflation.

Bory: Anything is possible. We don’t think that’s a good base case; instead we think there will be incremental changes that will have offsetting effects. As I mentioned earlier, the Trump agenda has four components. Two are very oriented towards growth, reducing taxes and loosening regulations on certain industries to help improve capital formation in the US. From an economic perspective, that should be a positive. We would want to see investment in corporations and different technologies in different industries in the US to help drive growth. That’s a strong positive.

The second question around tariffs and immigration are bigger issues that could have meaningful implications outside the country. Immigration is a unique US challenge. If you constrain labor at a time when the labor market is already tight, that could push up inflation. It’s good for workers, maybe not so good for profitability. So again, that maybe shifts the economy in the US, but it shouldn’t be destabilizing for the rest of the world.

The biggest challenge will be tariffs. As we’ve seen, Trump has suggested using tariffs tactically to try and negotiate better terms with our neighbors Canada and Mexico. And then also for where we have the biggest trade imbalance, with, say China, trying to improve the terms.

So we think the administration will be very sensitive to the economic considerations–trying to improve the US position within the rest of the world, but we don’t think that the administration is moving towards a reckless strategy. The worst-case scenarios are always possible, but the probability of a worst-case scenario we still think is fairly low.

Bory: Tariffs are the most difficult to predict, because we don’t know. They’ve been talked about, but they have not been implemented, which will take time.

Then, we don’t know how other countries will react. So it will take time to determine whether higher tariffs will be net positive or negative.

Tariffs went up meaningfully during the first Trump administration. The economy, both the US economy and the global economy, generally held up okay. We saw a modest slowdown in global trade, but it has been slowing for many years. While it’s not unique to tariffs, they could slow down global trade modestly.

Higher tariffs could lead to weaker yen

Bory: I think it would be mostly through tariffs, that would be sort of the most direct effect, and the dollar. The US dollar has gotten stronger, the yen has weakened. The Japanese currency was gaining some momentum earlier this year as expectations for rate cuts in the US aligned with rate hikes in Japan.

But since the election, that has started to reverse. We’re starting to see the dollar strengthen, not just against the yen, but against many currencies around the world. That may persist into next year.

A strong dollar that’s likely to be preserved into next year is one of our base-case assumptions. It’s a combination of the expectation that higher tariffs and tighter immigration kind of boosts inflationary pressures. That forces the monetary policy of the Fed to be less accommodating, which in turn creates an environment where the dollar is likely to remain strong.

That could be a challenge for Japanese investors. It could be a little bit of a challenge for Japanese purchasers of US goods. But a weaker yen versus the dollar also makes Japanese goods a little more competitive internationally. So maybe it helps a little from a demand perspective.

Bory: It depends on what the Bank of Japan does. But it looks like the pace of rate cuts in the US will slow.

We think there’s a possibility that they may cut rates another 100 basis points in 2025, but it will depend on the data, policy, and how inflation unfolds.

Starting from September, in the final four months of the year, the Fed may end up cutting rates a total of 100 basis points. They may take an entire year to cut rates the next 100 basis points.

So we expect the pace of rate cuts to slow as we go into 2025, and maybe ultimately stop as we get towards the end of the year.

Inflation still looms

Bory: We think the biggest challenge will be inflation, and inflation expectations. Our fixed income team worries about inflation.

If inflation remains well behaved, it will continue a kind of a slow path towards the Fed’s target of two percent. We’re still close to three percent.

If inflation continues to decline, forecasting of economic growth and activity becomes easier, and easier monetary conditions help boost the economy.

If inflation starts to rise or if inflation expectations become more volatile, it becomes more difficult to forecast throughout the year. We think that’s the biggest risk and perhaps the biggest challenge.