US Watch – Trump returns to office after working from home for four years

Despite securing a Republican Sweep of the Presidency and congress, Trump’s majorities are slim, and therefore any policy proposal is subject to possible dissent, or worse, filibustering. Dissent is likely given the controversial nature of a number of the proposals, and filibusters could derail his agenda, as overcoming them requires a 60% supermajority—a threshold Republicans do not meet. The envisioned solution is to use a single bill that addresses most of the proposals at once, pushed through budget reconciliation. Budget reconciliation is a process that allows for expedited tax, spending and debt limit legislation. It would have provisions on border security, including money for mass deportations, an extension of the 2017 Trump tax cuts, the raising or even eliminating of the debt ceiling, and various federal deregulation initiatives. The so-called ‘Byrd Rule’ limits budget reconciliation provisions to those that effect the federal budget, so all the above proposals have to be reframed in terms of spending or revenue. This is typically less exact than codifying into law, and therefore more subject to manipulation, although that is arguably the point here. The primary advantage for Republicans is that budget reconciliation is immune to filibusters, and therefore could be achieved by means of a simple majority vote. The hope is that the single large bill would contain sufficient positives for possible dissenting Republicans to refrain from voting against. Johnson, the Republican speaker of the house, explicitly stated that this allows them to not have to negotiate with democrats at all, and hoped to have the bill ready by May, and perhaps earlier. So what do we know about the contents?

Tariffs remain likely, and increasingly move from an economic to a political weapon. During his election campaign, Trump proposed 10 or 20% universal tariffs on all goods, and 60% on Chinese goods. The goal was economic, even if the economics do not support it. He believes that tariffs would be ‘paid’ by the exporting countries, implying they would cut their margins to keep prices constant in the US, or, if price cuts are not feasible and companies become uncompetitive in the US market, they would move production to the US. While sweeping tariffs on this scale have little precedent in modern history, tariffs in the first administration increased prices in the US, and did little to move activity to the US. Universal tariffs, particularly on intermediate goods - which make up more than half of total US imports - would not make US-based firms more competitive as the increase on their input prices also squeezes margins, suggesting the amount of activity moved to the US may again be limited. More targeted tariff policies – universal geographically, but non-universal in terms of products – might lead to more activity moving to the US.

After the election, Trump moved to using tariffs to obtain political goals beyond improving the US economy, threatening its closest trading partners, Canada and Mexico, with 25% tariffs unless they would counter illegal immigration and drug trafficking. China would also get an additional 10% for its role in exporting materials to synthesize the drugs. Trump played a similar game in 2019, when he threatened 5% tariffs on Mexico to pressure the country to do more to curb immigration into the US. This ultimately fizzled out. He also threatened the BRICS with tariffs if the countries challenged the dollar using a new common currency. There is no indication that they serious plans to do so. Regardless, the explicit threats offered a first glimpse at playbooks of countries at the receiving end, varying from fiery counterthreats to trying to appease Trump. For instance, while Canada initially played nice, earlier this week Canada made it clear they have a set of counter-tariffs ready if Trump launches a trade war.

The status of these various proposals, which are not mutually exclusive, is currently unknown. It is however clear that Trump’s team is working on the details of a tariff implementation. A proposal by his aides to narrow the tariff plan to only apply to limited critical imports was quickly dismissed by Trump himself. The latest news suggests they are considering a gradual implementation of ‘2 to 5% per month’ to limit the inflationary impact. The economic gains of tariffs are highly uncertain and mostly contested. What is clear is that any potential benefit to the US critically hinges on i) only a partial pass-through of prices (i.e. exporters need to absorb part of the tariff in their margin), and ii) limited retaliation. In a concerning twist, Stephen Miran, nominated to be the head of the Council of Economic Advisors, suggests that trade partners may be prevented from implementing retaliatory tariffs, by threatening to withhold defense support. Tariffs are therefore increasingly seen as an economic weapon to obtain political objectives, and actual weapons are used to prevent the economic weapon being sent back. As outlined in our Global outlook, implementation of widespread tariffs will put inflationary pressure on the US, contrasting with Trump’s campaign promise to bring down inflation. They will strengthen the dollar, contrasting with Trump’s campaign promise to correct the ‘overvalued’ dollar. Moreover, the tariffs are likely to hit at a particularly inconvenient time, with inflation still above target, and disinflation seemingly halting. The tariffs will distort global trade, also threatening the recoveries of the eurozone and China.

The debt ceiling is an ineffective tool which in its current form only damages the US’s fiscal reputation. The debt ceiling was reinstated on January 1st, and the new ceiling will be reached somewhere this week. After that point, the Treasury can still play around with accounting for a few more months. Without an expansion or suspension of the debt ceiling, the actual point when extraordinary measures would not provide enough cash for government activities, i.e. a US default, occurs somewhere in the summer.

The debt ceiling is not an authorization to spend money. Spending is determined and authorized by congress. The debt limit merely allows the government to meet these obligations. Before 1917, the Treasury required approval from Congress for all loans. During the first world war, Congress allowed the Treasury to sell war bonds as needed without approval, as long as the total amount didn’t exceed a debt limit. This limit has periodically increased, but importantly is nominal, and unrelated to GDP, unlike for instance the European Stability and Growth Pact, which puts boundaries on the debt-to-GDP ratio. Even with sustainable deficits, and a stable debt-to-GDP ratio, the US will consistently run into debt ceiling issues.

The debt ceiling was intended to ensure fiscal responsibility, but it does not actually limit spending, as congress can easily approve spending beyond the limit. Treasury than runs into trouble if it cannot fulfill its obligations, already legislated by Congress. They transfer the problem back to Congress which has to either raise or suspend the limit to prevent the government from defaulting. Over the past decade, this has led to political standoffs and economic uncertainty. Notably, in 2013, Congress waited until the last possible moment to raise the debt ceiling, and investors had already sold off treasury securities maturing around the projected limit date. In 2017 yields similarly spiked around the projected limit date.

At the end of last year, congress was close to a deal to extend the deadline until March, but Trump stopped the deal from going through after Musk found the deal to be ‘full of excessive spending.’ Musk and Trump put their weight behind an alternative bill which could only garner support of 42% of congress, with many Republicans opposing the bill.

Trump has repeatedly come out as in favor of abolishing the debt ceiling entirely, although perhaps for the wrong reasons. The advantages of abolishing the debt ceiling may very well outweigh the costs. One would lose an ineffective fiscal discipline tool, while avoiding repeated political crises and the resulting economic uncertainty. Financial markets would still be in place to discipline fiscal spending and increase government debt yields when debt and spending become unsustainable. [1]

Bessent’s 3/3/3 is achievable, but not with the rest of Trump’s policies. Scott Bessent, the incoming Treasury secretary described his goals as a 3% growth rate, a deficit of no more than 3% of GDP and an increase in oil production of 3 million barrels per day. Projected GDP growth for 2024 is close to 3%, and while the target is above the long-term trend growth, it is possible to achieve 3% for an extended period at the peak of the business cycle. Both Clinton and Reagan achieved it in their second term. Although productivity has increased substantially in the past years, a large part of recent growth can be attributed to growth in the labour force, which may not be possible if the Trump administration is successful in stemming the immigration flow, or deporting illegal immigrants already in the US. Higher inflation from tariff policies will keep the Fed rate restrictive, making it substantially harder to reach the growth target.

The distance to the 3% deficit is much larger, with the 2024 deficit projected to be 6.7% of GDP. The gap to 3% is about $1 trillion, and that’s substantial. It would amount to raising revenue by 21%, decreasing spending by 16%, or some combination thereof. The various policy proposals would only add to the deficit. For instance, extension of the Trump tax cut would almost half a trillion per year, according to the Congressional Budget Office. Income from tariffs would never make up for that. The Department of Government Efficiency, that will be led by Musk, has the aim to cut costs by approximately $1 trillion (down from an initial estimate of $2 trillion), although it is not yet clear how they would achieve this. It seems like a near impossible goal, given that it’s effectively the entire non-defense non-discretionary budget.

The final ‘three’ is increased oil production. As it stands, the US produces about 13 million barrels a day on total output of 100 million barrels. Another 3 million barrels may not even be possible, despite extensive deregulation. Even if that amount would currently be untapped, the increased supply might decrease prices to a point where it would no longer be economically viable to extract it. Indeed, US domestic shale producers need higher prices to support the investment case for higher oil growth.

Fed Governor Barr stepping down is a concerning signal for Fed independence. Michael Barr, the Fed’s vice chair for supervision announced he would step down from his role, in order to avert a messy legal fight with Donald Trump to replace him. Republicans have long been critical of his efforts for the ‘Basel endgame,’ a stepping up of regulation of banks, whose scope was severely toned down in September after substantial critique. The election of Trump all but killed even this weaker version of the regulation package.

Barr stated that he was afraid a potential legal battle would be a serious distraction to the Federal reserve and its ability to serve the people. He added that both his own lawyers and the Fed general counsel agree that he would win this legal fight, but that it would be ‘deeply unpleasant.’ The voluntary stepping down is a concerning development. When Chair Powell was asked by reporters whether he would step down if asked by the Trump administration, he gave a firm ‘no,’ also explicitly mentioning his legal standing. Barr stepping down due to outside influences from the incoming Trump administration is a blow for central bank independence, and arguably does greater damage to the Fed then any legal battle might have done.

Governor Michelle Bowman, who’s been critical of the tougher regulation on the sector is seen as the top candidate to replace Barr. More recently, Bowman stood out as being the only dissenting vote in the 50 bps cut last September.

Calls for territorial expansion are shocking. Trump has repeatedly suggested Canada become the 51st state of the US, and wants to add Greenland to its territories. He also wants the Panama Canal back and rename the Gulf of Mexico to the Gulf of America. When asked whether he would use military force to achieve these goals he refused to rule it out.

Canada appears to have no interest in joining the US, and interestingly, the size of its population and political leaning would suggest a Republican might never take office again after the next election.

Greenland is currently an autonomous, but subsidized, territory within the Kingdom of Denmark, with Denmark retaining control of foreign affairs and defense. Unsurprisingly, Trump threatened that he ‘would tariff Denmark at a very high level’ if it resisted Trump’s plans for Greenland. Putin has now suggested the US and Russia may share Greenland. Indeed, the island is of significant strategic importance, both in terms of military control in the arctic – the US already has a large military presence on the island - and increasingly, economic considerations. Climate change has a chance of opening up new shipping routes and access to increasingly important natural resources that were previously inaccessible. At the same time, the latter should not be overstated, as the estimated availability is still relatively small on a global scale. Oddly, control of Greenland is not as outrageous as it might seem; he might be able to convince or bribe the 57k inhabitants of Greenland to vote for independence from Denmark, after which they could move closer to the US.

As for the Panama canal, Trump asserted it was operated by China rather than Panama, a statement that appears to be based on the presence of two ports on either side of the canal, which are operated by a Hong Kong-based company. The US built the canal in the early 20th century, and gave it to Panama in 1999 under the condition that it would be free for any nation to use, and indeed, all countries’ commercial and military ships are treated equally. The economic importance of the canal is clear, as it slashes about 11,000 km off a journey that would otherwise have go around the southern tip of Southern America. There is no indication that there is any threat to the US’ economic or military use of the canal.

The influence of Musk is already substantial, and has the potential to hit the macroeconomy. Musk’s official position is heading the ‘Department of Government Efficiency,’ tasked with slashing federal spending. Unofficially, his influence has been much wider. He played a consequential role in slashing the bipartisan bill on the debt ceiling highlighted above. He changed Trump’s view on H-1B visas, a non-immigrant visa for specialty occupations. While Trump limited the visas’ use in his first presidency, in a general effort to curb immigration, both legal and illegal, he has now taken Musk’s side in making the distinction between the two, calling the H-1B visa ‘a great program.’ Musk has also been present in many meetings with foreign officials, including Ukrainian President Zelenskyy, French president Macron, and Italian Prime minister Meloni, who Musk referred to as a ‘precious genius.’ This raises potential questions about his influence on foreign policy as well.

In his official role as head of DOGE he is looking to curtail spending. When taking over ‘X,’ Musk used his ‘slash first, fix later’ doctrine. A large part of cost-cutting came from firing almost 80% of its workforce of employees and refusing to pay vendors, the latter part of an almost Trump-like negotiation tactic to reduce prices. Government hiring accounted for 20% of the new jobs in the 2024, and 15% of all jobs in the US. Only 1.9% of jobs in the US are federal government jobs, where Musk would have most potential to cut jobs. Still, even cutting 10% of the total government workforce would more than undo the total job creation of 2024. The fact that his private companies have government contracts with many different government agencies adds an additional layer of complication, where he may be highly selective on where to cut, and which vendors to pay.

At the same time, Trump has described Musk as clingy, while the general public is joking that Musk is the man in power, rather than Trump. An explosive fallout between the two is conceivable, at which point Trump of course has the institutional backing to take back the reigns.

Preliminary policy is still mostly consistent with our baseline assumption. The developments are generally supportive of the assumptions in our base case that we documented in our Global Outlook late last year. We anticipated tariffs to be the major shock determining the broad developments in the major economies over 2025 and 2026. The administration is doubling down on tariffs, and a gradual implementation, as assumed in our base case, seems likely. At the same time, the ultimate magnitude and timing of these policies are likely to alter our projections for growth, inflation and the central banks’ policies. The inauguration marks the start of a new chapter for the US and its economy. We’re in for a wild ride.

[1] The dollar’s reserve currency status likely pushes the definition of ‘sustainable’ beyond the threshold for most other economies. At the same time, risk premia on US government bonds are currently increasing, partly in response to the US’ debt trajectory. Even as a reserve currency, there is a limit to how much debt will be accepted by the market before yields rise substantially.