Donald Trump's election win and 'his iconic victory dance moves' has cheered the global stock markets with the benchmark indices across the world gaining between 1.5 to 3 percent. But as the 47th President of the United States of America (USA) sticks to his poll promise, it could unleash a wave of tariff hikes and a trade war between the US and China, stoking up inflation to an unprecedented level and thereby drastically limiting the scope for the Federal Reserve to cut interest rates - at least that is what the bond markets are telling us.
The US benchmark 10 year bond yield is up nearly 11 percent in less than a month in anticipation of a Trump victory. On November 6, the 10 year yield spiked up by more than 3 percent as Trump delivered his late night victory speech in Florida and said he would stick to his promises. It means the interest rates in the US have already gone up by nearly 1 percent and the Fed has a tight leash to walk. The 10year bond yield in the US witnessed its biggest monthly spike in October since September 2022.
While Trump is expected to just play to the gallery on most of his promises, yet his rethorics and imposition of 60 percent tariff on imports from China will hurt the global trade sentiments as the Communist regime there retaliates. Trump is largely expected to follow through on his campaign promise to deliver a statutory tariff rate of 60 percent against imports from China and broader 10 percent tariffs on other countries within weeks of his taking charge in January 2025. This apart, he may also introduce big tax cuts and steep tariffs, which could spark economic growth but also widen the fiscal deficit and reignite inflation.
As per a Nomura client survey report, negative impact on the federal funds rate from a second Trump presidency is expected by the end of 2025. "Combative trade policy would likely weigh on economic activity, which is dovish. However, we think it would take some time for the Fed to assess inflationary shocks stemming from higher tariffs before resuming rate cuts."
Since Trump has an absolute majority in the senate and the Congress, he would have his way on the tariffs. How quickly Trump imposes tariffs, any negotiation with Europe and China that could limit them, and any offsetting exchange rate adjustments could all affect the economic fallout. Trade analysts are building up a base case scenario of an average effective tariff rate ramp up by Trump to around 11-12 percent in 2026, before the substitution cools and bilateral deals bring it back down to 7- 8 percent. This may be a substantial increase from the current effective tariff rate of 2.5-3 percent by the US As Republicans have swept the polls completely and may also have a control over the house, President Trump would have the legal authority to impose many tariffs without congressional approval. However, prior trade agreements (e.g the USMCA), may curtail some of Trump's discretionary powers but it is unlikely to prevent an aggressive Trump from eventually attempting to impose tariffs even against North American trade partners. In case of a global tariff war, consumer price inflation may see significant boost and US growth may also suffer.
On Thursday, the US Fed will be making its next decision on interest rates and is widely expected to slash rates by a quarter point. Market rally around the world has been in anticipation of interest rate cuts by central banks. But with the changed scenario, the global central banks would take a cautious view on rate cuts now.
"Although Trump has shown a consistent preference for easy monetary policy, we believe that the Fed would engage in a less aggressive cutting cycle under a second Trump administration due to the inflationary nature of additional tariffs. By contrast, our client survey showed many market participants expect some negative impact on the federal funds rate from a second Trump presidency by the end of 2025. Combative trade policy would likely weigh on economic activity, which is dovish. However, we think it would take some time for the Fed to assess inflationary shocks stemming from higher tariffs before resuming rate cuts," Nomura says.
Analysts are also skeptical about Trump being able to significantly dictate the Fed policy in a direct manner. "Trump originally appointed Fed Chair Powell in 2018, but he has since indicated that he would not reappoint him. Chair Powell’s current term runs until May 2026, and Supreme Court precedent suggests Trump would be unable to fire Powell without cause. Considering Trump’s preferences, we expect his Fed appointees to be dovish. However, we believe Trump’s ability to appoint disruptive Fed Governors would be limited. Any Trump appointee would need to be approved by the Senate. In 2020, the Senate (with a Republican majority) refused to confirm Judy Shelton, an unorthodox appointee to the Board of Governors. Similarly, anticipated Senate resistance also led Trump to withdraw the nomination of Stephen Moore to the Fed," Nomura says.
