As President-Elect Trump’s new administration takes shape, all
eyes are on fiscal policy that may follow. Our Global Chief
Economist Seth Carpenter uses the United Kingdom’s recent
election as a guide for how markets could react to a policy shift
in the US.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan
Stanley's Global Chief Economist, and today I'll be talking about
the US election and fiscal policy and what lessons we might be
able to draw from the fiscal experience in the UK.
It's Wednesday, November 13th at 10am in New York.
In a lot of our recent research, the US election has figured
prominently, and we highlighted three key policy dimensions that
the US administration is going to have to confront. Immigration,
tariffs, and, of course, fiscal policy. We're going to keep
elections as a theme, but it might be useful to draw some
comparisons to the UK to see what lessons we might have for the
US.
We think the experience in the UK, which recently proposed a new
fiscal budget months after an election, is relevant mostly
because of the time between taking power and the budget being
presented. While markets are in the business of anticipating
changes, the process of actually creating policy is a lot more
cumbersome and time consuming.
In this week, where we've seen lots of expectations already being
priced in, it's probably useful to try to think about that
process of forming policy in the UK and see what lessons it
implies for the US.
Back in May, the UK elected a new government, changing party
control after 14 years. A key moment for markets came just over a
week ago, though, when the new government's presentation of their
budget for the next fiscal year came up.
Now, we should remember, the trust government had faced a market
test when the announcement of their budget proposals led to a big
sell off in interest rates. As a result, markets were keenly
attuned this time to the new labor government's budget,
particularly because the US fiscal position requires a primary
balance to stabilize the debt to GDP ratio. And in particular,
when their debt costs rise, when interest rates go up, the
primary balances that are needed keep increasing if they want to
keep the debt stable.
Now, the new labor government proposed to fill a funding gap
through tax increases while simultaneously increasing Government
investment spending. To manage some of the communication
challenges here, many of these proposals, especially about the
tax increases, they were made public in advance. The likelihood
of additional government spending was also well known, and UK
rates had moved higher for months leading up to the formal
presentation of the budget.
But, markets reacted on the day of the budget reveal, despite all
of that prelude. The degree of front loading of the investment
spending was seen as a surprise in markets, as was the Office of
Budget Responsibility's concurrent assessment that the policy
would lead to higher growth, higher inflation, and as a result, a
need for higher interest rates.
Now, conversations with clients have brought up the similarities
of the US and the UK. US interest costs are steadily rising
as the cost of the debt reprices to the current yield curve. And,
over time, the ratio of interest expense on the debt relative to,
say, the GDP of the country, well, that's going to continue to
rise as well, and it will very soon eclipse its previous all time
high.
So, fiscal consolidation would be needed in the United States if
we really want to see a stabilized debt to GDP ratio. Markets
will need to assess the credibility of fiscal policy and the
scrutiny will increase the higher the interest burden gets. The
budget process for the US is much less clear cut than that in the
UK and deliberations and debates will likely happen over most of
2025. And there's an additional question of how much revenue
tariffs might be able to generate on a sustained basis. History
suggests that trade diversion tends to limit those revenue gains.
All of these facts taken together suggest that the outlook for US
fiscal policy will continue to evolve for quite some
time.
Well, thanks for listening, and if you enjoy this show, please
leave us a review wherever you listen to podcasts and share
thoughts on the market with a friend or a colleague today.
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