If Trump ends up winning the election and imposing major restrictions on immigration and trade, in addition to implementing his proposed tax cuts just shy of $1 trillion, this could result in the US economy overheating, stated Papadakis.
“Assuming the US economy no longer suffers from significant demand deficiency and is now relatively close to full employment, a view that the Fed also appears to hold, tax cuts of such scale could cause the economy to overheat, triggering an inflation overshoot and sharp interest rate increases. Reduced labour supply would result in a tough adjustment process as employers suddenly face labour shortages and are forced to push wages up. Meanwhile, an aggressive US stance on trade including imposing tariffs would increase the prices of imports, adding to inflationary pressures. A combination of higher inflation, higher rates, and risk aversion caused by a “trade war” environment can be expected to slow down the economy.”
Papadakis also suspects that the Federal Reserve will become more “hawkishly-inclined” if Trump is elected president. Trump has previously stated that he is disinclined to re-appoint Janet Yellen at the end of her term in February 2018. Assuming that the Republican party maintains its majority within the Senate, he argued Yellen’s replacement “is likely to be more in line with the current Republican party mainstream, which tends to be critical of policies such as quantitative easing and in favour of earlier and faster rate hikes.”
“We expect that a Fed Chair candidate holding such views would cause the markets to reprice the US interest rates term structure significantly higher from current levels. A more hawkishly-inclined Fed combined with inflationary pressures and overheating risks for the US economy would present a potent mix, threatening to generate significant dollar appreciation.”
