DAVID KOCH: If he keeps his election promises, Trump 2.0 could bring sky-high inflation back to US economy

Financial markets hate uncertainty and they hate disappointment. Wednesday’s Wall Street crunch is a classic example of that.

The disappointment and uncertainty is focused around interest rates. That’s why the “Santa rally” of American stocks came back to earth with a thud and it could be contagious globally.

Overnight, the US Federal Reserve, as expected, cut official interest rates back to a 4.25 to 4.5 per cent range but it was what Fed boss, Jerome Powell, said in his press conference that spooked markets. With Trump — and his election promises of tax cuts and tariff increases — set to come into power in 2025 there is considerable speculation it will cause a rebound in inflation.

The Fed aggressively increased official interest rates in 2022 and 2023 to fight inflation... and it succeeded. Job done. The reward for that aggression was an interest rate cut of 0.5 per cent in September and another 0.25 per cent last month. Markets were also expecting a string of rate cuts in 2025 and the Fed had been encouraging that thinking.

But on Wednesday, America’s central bank blinked. Powell said any further rates cuts would be dependent on further progress of inflation trending down and the jobs market staying solid but not overheating.

In January, US political power shifts to Donald Trump and his raft of election promises. If he delivers on those election policies then inflation is heading back up in the US and the size, and speed, of any future rate cuts are in jeopardy.

It’s a big “if” on whether Trump will follow through with those election promises. There is a school of thought that Trump simply follows the traditional political strategy of “say anything to get elected and then, once in power, do whatever you like”.

Just as Trump 1.0 showed, he does tend to talk a big game and often doesn’t follow through on some of his more outrageous plans. That plan to build a wall along the Mexican border and get the Mexican Government to pay for it didn’t turn out as planned. In fact, only an extra 80 miles was added to the already existing walls during Trump’s last term as president.

So, there is some scepticism about the promises of Trump 2.0. Let’s hope that scepticism is right. If it’s not, then US inflation is back in a big way.

Trump’s plan to deport all illegal migrants is just a crazy idea which will lead to labour shortages, sparking wage rises and potentially corporate failures across key industry sectors.

The logistics behind the mass deportation of millions of illegal migrants alone are hard to comprehend. But the impact on key industries would be devastating.

The construction industry workforce consists of 14 per cent illegal migrants (1.5 million workers). Thirteen per cent of agricultural workers are illegal (244,000 people) as are 7 per cent of hospitality workers (1 million workers). Take those migrants out of the workforce and those industries would teeter on the edge of collapse.

Not only would the resultant supply chain disruption add to inflation but the labour shortage would spark big wage rises as employers compete for replacement staff at a time when unemployment is already at a low 4.2 per cent

And, as a side note, 47 per cent of all undocumented immigrants live in California, Texas and Florida. These are the three economic powerhouses of the US economy. A workforce loss of that magnitude would bring those states to a standstill.

So when Jerome Powell talks about the state of the labour market when determining future interest rate cuts, Trump’s deportation plans will be a significant factor.

Then there’s Trump’s tariff policies to supposedly protect the jobs of American workers. His theory is to make imported products more expensive to encourage consumers to buy locally manufactured products and to discourage US companies from manufacturing overseas.

He has already announced that on his first day in office he will impose a 25 per cent tariff on Canadian and Mexican imports and add another 10 per cent on Chinese imports to the tariffs imposed during his first term in office, which President Joe Biden maintained.

Sounds very patriotic in theory but these three countries are the major suppliers of products to US consumers and the tariff increases will be passed onto consumers. One US economic think tank estimates these tariff increases will increase the annual costs to US consumers by $US 2600 a year.

The US share market has had a stellar 2024 led by the so-called Magnificent 7 technology stocks and the prospect of further rate cuts. But the future looks a lot more uncertain with Trump in power.

David Koch is economic director of Compare the Market