WEEK AHEAD

"We are moving policy over time to a more neutral setting. But the path for getting there is not preset. In considering additional adjustments to the target range for the federal funds rate, we will carefully assess incoming data, the evolving outlook, and the balance of risks. The economy is not sending any signals that we need to be in a hurry to lower rates. The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully."
— Federal Reserve Chair Jerome Powell, Dallas Chamber of Commerce, November 14, 2024

The Road Not Taken - Where Do We Go from Here?

The results of the 2024 election are not quite complete, but the significant changes are final and clear. The Republicans have won control of the Presidency, the Senate, and the House of Representatives. President-elect Trump has promised changes in economic policies, and changes in the size and distribution of returns across capital markets are likely.

President Trump's plans for economic policy are ambitious, and there is a large gap between plans and implementation. While the Republicans control both the House and Senate, some of the policies advanced during the most recent campaign may not become law if members of Congress find them too unique and outside the narrow options for policy chosen in the past.

Through the veil of uncertainty, some general characteristics are visible. There will likely be no increase in corporate tax rates, personal income tax rates, capital gains tax rates, and the inheritance tax rate. All these rates would have increased if the current tax schedule were allowed to expire in 2025 as planned.  The Republican majority will not allow these tax rates to rise if they are to fulfill promises made during the campaign. President Trump stated that if elected, he would eliminate the tax on Social Security income and the taxes on tips. The Democrats offered their own plans to do the same; therefore, there is a high probability these changes to the tax code will be enacted.

The most controversial of President Trump's proposed policy changes is his plan to significantly increase tariffs on imported goods. The objectives of the increases are to save US jobs by making goods produced in the US more competitive with goods produced overseas and to punish those countries deemed to have violated trade agreements.

Section 301 of The Trade Act of 1974 provides a basis for determining when tariff increases are justified, and trade sanctions are appropriate. These sanctions usually follow a determination that foreign countries have violated trade agreements or have engaged in acts that are unreasonable and harm US commerce.

Both President Obama and Biden have imposed Section 301 tariffs, as have other Presidents. In September of 2024, President Biden imposed tariffs that ranged from 25% to 100% on a list of goods imported from China. President Obama imposed tariffs as high as 47% on solar panels and automobile tires imported from China.

The US has imposed tariffs on imported goods for more than 200 years. In the early nineteenth century, tariffs produced about 80% of all Federal tax revenues. Currently, tariffs produce about 2% of all Federal tax revenues.

The current controversy arising from the scope of President Trump's proposed increase in Tariffs has stimulated a reexamination of the consequences of the Smoot-Hawley tariffs of 1930. After the tariffs were imposed, foreign governments responded by raising tariffs on US goods. The total amount of US imports and exports fell by an estimated 67% as the tariffs acted as barriers to international transactions. The Smoot-Hawley tariffs were imposed after the beginning of the Great Depression as part of an effort to protect domestic US industries from foreign competition and thereby "save" US jobs. The consensus among economists is that tariffs reduce economic activity and raise unemployment.

Tariffs have much the same impact on economic activity as taxes, and both levies reduce economic activity. President Trump's proposed increase in tariffs stands in contrast to his intention to lower tax rates and reduce regulations. Should significantly higher tariffs become a reality, there will be winners and losers among US companies. For example, on average, smaller companies with limited exposure to foreign trade will likely see a relatively better environment for their sales and profits when compared to larger companies that have sales and profits with a more significant exposure to international trade.

Yet another source of uncertainty is the behavior of the Fed as changes in economic policies become a reality. President Trump's proposals thus far, make no specific mention of looming large Federal budget deficits driven by increases in government spending. He has indicated he intends to reduce waste and inefficiency, but similar efforts have in the past met stiff bipartisan resistance from members of Congress. Moreover, any attempt to reduce the size of the deficit that does not address the surging costs of Social Security and Medicare will be inadequate. Thus far, no member of either party wants to suffer the political consequences of reigning in the rate of growth of these two programs. The Fed will be faced with a choice of monetizing the projected deficits and raising the rate of inflation or resisting the pressure to increase liquidity and risking the consequences large Treasury borrowings will have on credit markets.