Our Global Head of Fixed Income and
Thematic Research joins our U.S. Public Policy Strategist to give
investors their policy expectations for President-elect Trump’s
second term, including the potential market and economic
consequences of those policies if enacted.
----- Transcript -----
Michael Zezas: Welcome to Thoughts on the
Market. I'm Michael Zezas, Morgan Stanley's global head of fixed
income and thematic research.
Ariana Salvatore: And I'm Ariana Salvatore,
U.S. public policy strategist.
Michael: And on this episode of Thoughts on
the Market, we'll talk about potential policy paths the
second Trump administration might pursue.
It's Monday, December 23rd at 10am in New York.
The U.S. presidential election is behind us and we're well into
the holiday season, but we're still focusing closely on what U.S.
policy might look like in 2025. Ariana, what have we learned in
the past couple of weeks regarding Trump's policy plans for next
year?
Ariana: So the variables or policy items
that we're watching are still the same ones that we were tracking
over the past year or so. That's tariffs, taxes, immigration and
deregulation. But to your point, the election is now
obviously behind us, and we do have some incremental information
that's helped us construct a base case across these variables.
For example, President elect Trump has made some key personnel
appointments that we think are going to play a big role in
exactly how these policies are carried out. His pick for
Treasury Secretary, Scott Besant, is a good example that gives us
conviction in a more gradual, incrementalist approach to tariffs.
Translating that principle across all the policy variables, as
well as the extremely thin majority the Republicans have in the
House of Representatives, has helped us form the foundation of
our base case, which we call “fast decisions, slow
implementation.”
In short, we think that means you should expect major policy
changes will be announced quickly, think first quarter of next
year, but achieved more slowly. That, in our view, enables more
benign macro conditions to persist into 2025, but does create
some more uncertainty, both positive and negative,
into 2026. We think that lag is attributable to a
variety of logistical, legal, and political constraints, and does
vary depending on the policy area and executive authorities. For
example, we think Trump might have an easier time unilaterally
modifying tariff rates, but other constraints outside of timing
might limit implementation nonetheless.
So, Michael, taking this a step beyond just the policy paths, how
should investors be thinking about the potential market and
economic consequences of our base case? Aside from the specific
policy changes, how do you think about our base case in terms of
broader market themes?
Michael: I think the key takeaway here is
that the policy path we're describing puts pressure on economic
growth, but on a lag. So most of these effects are for later
in 2025 or into 2026 per economist expectations. So I
think the key takeaway here is that the policy path we're
describing exerts pressure on economic growth, albeit on a lag.
So in our economist expectations later in 2025 and into 2026. So
what that means is as we go into 2025, there's still a pretty
good growth backdrop to support risk assets and equities in
particular. It's also a pretty good backdrop for bonds because as
we get closer to 2026, our bond strategist expectation is that
markets will start to reflect expectations of growth pressure.
And they'll probably be less concerned about what's a debate
right now, which is the size
of U.S. deficits. There's been this expectation
that policies extending tax cuts would really grow the deficit
substantially in the way that might put downward pressure on bond
prices.
However, we think when investors take a closer look, they'll
see that extending current tax cuts, which is our expectations,
basically, they'll be able to extend current tax cuts with a few
sweeteners on top, that's mostly an extension of current policy,
as opposed to some of the headlines in the news talking about
major deficit expansion, that's an expansion relative to if
Congress did nothing and just let tax cuts expire. So the
year over year difference in deficits is perhaps not as big as
some of the headlines would suggest. So that's a good backdrop
for bonds and a pretty good backdrop for equities and risk
assets, at least to start the year.
Ariana: But of course, there's a lot of
uncertainty embedded in these policy paths. Can you talk through
how we're thinking about potential risks to our base case, or
maybe some key signposts that could indicate that other scenarios
are becoming plausible?
Michael: So if there are policies that
shift that growth downside sooner, so instead of it manifesting
in 2026, it manifests sooner in 2025, that's the type of thing
that might make us less constructive on risk assets and
equities. So if we got indications, for example, that
tariffs were going to be implemented more quickly and to a
greater degree, for example, announcements happening quickly, but
also showing implementation is happening very quickly, that's the
type of thing that might skew risk assets in a more negative
direction. Similarly, if Congress were to pledge to appropriate
more powers to the executive branch on tariff authority, not
necessarily something we think they could get done, but that
could be an indication that there could be more powerful tariff
potential relative to what the executive branch currently has.
On the more positive side, if Congress indicates that it
wants to move much faster and bigger on tax cuts and the
executive branch were to flag that tariffs are going to be
implemented later or suggest that there's more negotiating room
with trade partners to avoid tariffs, then that might be the type
of sequencing of policy that enables the market to focus
more on the good aspects of policy, the helpful aspects to
corporate earnings, to individual consumption, and to GDP growth
that might just make for an all around more conducive environment
to risk assets.
So there's a lot to keep an eye on between now and inauguration
day. In the meantime, enjoy your holiday. Ariana, thanks for
taking the time to talk.
Ariana: Great speaking with you, Mike.
Michael: And as a reminder, if you enjoy
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