We were already expecting loose US fiscal policy and higher interest rates across the curve on average than pre-pandemic. This week’s US election results push our view further in that direction.
It is the nature of event risk that, when it is finally realised, it closes off some potential futures and narrows down the remaining possibilities. As we flagged back in July, elections can be such an event risk. Schrödinger’s November box has been opened, and we now know that, not only did the cat turn out to be red, but it seems to be accompanied by two little red kittens called ‘Senate’ and ‘House of Representatives’.
We do not yet know exactly what the incoming Trump administration’s fiscal and trade policies will be, but we have a sense of the direction. Relative to the superposition of red and blue possible futures, fiscal policy will be at least a bit more expansionary. It will also be skewed more to tax cuts than spending, meaning that more of the extra demand will be private sector not public sector. Recall, though, that both parties were promising a continuation of the current large fiscal deficits. Fiscal consolidation was not on either side’s agenda. So the now-likely future is a difference at the margin from our earlier view, not a complete departure from it.
In addition, the proposed tariffs will lift the price level in the United States, boosting measured inflation for a time and raising the relative price of traded goods relative to non-tradeables.
We were already expecting that the global interest rate structure would be higher in the future than it had been in the period between the GFC and the pandemic. This has been a core part of our house view for some time. The large US fiscal deficits, which would have continued regardless of the election result, were among the factors underlying this view.
With one fork in the road now closed off, though, some further evolution of that view is in order.
At the margin, the expected demand impulse from the next Trump administration’s likely fiscal policy will be larger, and more inflationary, than our existing base case. Bond markets are already adjusting to this. The result is higher bond yields across the whole US curve. The US bond market’s dominant position globally means that most of this uplift also flows through to our view on Australian bond yields. Because Australia’s fiscal position is stronger than in the United States, we continue to expect the spread between Australian and US long yields to be narrower than historical norms.
Trump’s tax cuts and tariffs push the US inflation outlook up. This will take a while to come through, though, given that it will likely be well into 2025 before they are enacted. We have therefore not shifted our view of near-term path for the Fed funds rate. The Fed cut rates by 25 basis points at this week’s meeting as expected, and we continue to expect the Fed funds rate to reach its low point of 3.375% (midpoint) in the third quarter of 2025.
In contrast, we do think the outlook further out has shifted from our earlier expectations. Recall that we already expected the Fed funds rate to bottom out at a higher rate than implied by the FOMC ‘dot plot’, consistent with our view about the longer-run global interest rate structure. That view seems even more likely given recent developments. Further, we now think it likely that the Fed will start hiking rates in the second half of 2026, in response to rising inflationary pressures. While it is too soon to know what Trump’s immigration policies imply for US population and labour supply, and so the domestic cost base, a shift here is likely to reinforce the inflationary implications of Trump’s other signature policies.
We do not see the same inflationary impulses in Australia, especially given that rising labour force participation here has been a positive for labour supply and is likely to remain so for a while. In addition, the impact of tariffs on China could be indirectly negative for Australia, given its importance as a destination for our exports. Against that, though, we need to be mindful that China is likely to respond to any negative external shock with additional stimulus targeting the consumer and residential investment, lifting commodity demand. We would also see Australia as one likely destination for all those cheaper manufactured goods that a tariff-bound United States no longer demands. This implies some downside risk for the relative price of goods relative to services in Australia, and to inflation more broadly. We have therefore not revised our view on the RBA cash rate in light of Trump’s victory.
The relative shift in rates suggests a stronger US dollar, and so we have flattened the slope of the expected appreciation of the AUD (and NZD) against the USD accordingly. Relative purchasing power tends to be the centre of gravity that exchange rates revert to over the 3–5 year horizon, but it now seems that this will take longer than we previously assumed.
