Donald Trump has been in office for some three weeks now and the era of unpredictability has begun. Anyone who thought that Donald Trump would only bark but not bite has been proven wrong. In his second term in office, Donald Trump seems to be better prepared and more determined to deliver on his election promises than during the first term.
During the election campaign, Trump promised to 'make America great again'. By implementing policies such as tax cuts and deregulation, in order to create a pro-business environment, by taking a tough anti-immigration stance to strengthen the domestic labour market and by applying a strict trade policy to boost domestic production. Immediately following his inauguration, Trump signed various executive orders and documents, such as the withdrawal from the WHO and the Paris Climate Agreement, the start of deportations or the setting up of the Department of Government Efficiency. All those measures, by the way, closely follow the conservative agenda of ‘Project 2025’, a project Donald Trump during the election campaign always denied to support.
As regards tax cuts and tariffs, Donald Trump had not shown the same speed of pushing through with policy changes. Up to now. More than a week ago, Trump announced tariffs on on Canadian, Mexican and Chinese goods. However, a deal was reached with Mexico and Canada at short notice, resulting in a postponement of these tariffs by one month. With China, there was no such deal. Instead, China announced to impose retaliatory tariffs. Moreover, on Super Bowl night, Trump stated that he would impose import tariffs of 25% on aluminum and steel - with Canada, Brazil and Mexico being particularly affected. In addition, he said, tariffs would be imposed on imported goods from any country that imposes tariffs on US goods.
It's not the easiest task to look through the persistently high number of headlines or the back and forth of announcements - yet it's necessary to get a glimpse of the bigger macro picture.
What does Trump 2.0 mean for the US?
In the short term, Trump's America First policy and, above all, the pro-business approach is likely to be positive for the US economy. Companies that have been cautious to invest are more likely to start spending as a result of a more favorable business environment with lower corporate taxes, deregulation and (even) lower energy prices. The longer-term outlook, however, is less optimistic. The US labour market is heavily dependent on non-US workers, particularly in the service and construction sector. Roughly one quarter of all employees in these sectors are foreign born employees. Overall, the share of foreign-born employees in total US employment stands at around 20% - up from around 15% ten years ago. Reduced immigration could therefore become a major constraint on the US economy in the future while adding to wage and inflationary pressure at the same time.
Trump's trade policy is also likely to backfire. For two reasons. Firstly, import tariffs are not paid by the foreign producer exporting to the US, but rather by the US importer in the form of an extra tax. The US importer has two options then: bearing the extra tax in full and thus reducing profit margins or passing it on to consumers. Past experience has shown that the latter is more likely to happen. The consequence is higher consumer prices, i.e. higher inflation. At least if US consumers are unable to substitute imported goods with domestically produced goods. And even if consumers could substitute, US producers might increase their profit margins. On the other hand, countries subject to US tariffs are likely to react. Take China as the latest example, which reacted to the imposition of a general tariff of 10% on Chinese goods by in turn imposing tariffs of 15% on coal and of 10% on crude coil, agricultural machinery, large displacement vehicles, and pickup trucks from the US.
Overall, “America First” will primarily lead to higher inflation in the US - not only resulting from tariffs but also owing to a potentially tighter labour market. It is unlikely that the Trump administration will be able to reduce inflationary pressure via deregulation and increased energy production. For the Fed, this means that the scope for interest rate cuts looks set to be limited. Financial markets are currently expecting one to a maximum of two interest rate cuts by the Fed of 25bp each by the end of the year.
In the longer term, growth prospects could also be dampened by fiscal sustainability concerns. Trump's spending plans will be difficult to finance, revenues from import tariffs won't be enough. Accordingly, investors are likely to demand a higher risk premium for lending money to the US, leading to higher bond yields. As a result, lending rates would rise, probably dampening companies' and households' investment activity in the longer term.
What does Trump 2.0 mean for Europe?
For Europe, an economic nightmare has come true. Already without the risk of an impending trade war or further competitiveness losses, Europe is not really in a healthy economic position. The eurozone economy grew by 0.7% in 2024, with the recovery, that had started at the beginning of the year, slowing towards the end of the year. The ongoing weakness in industry weighed particularly heavy on economic activity. Looking ahead, with order books shrinking by the month and inventories remaining at stubbornly high levels, there is no sign of a revival in industry just yet. Private consumption does not yet provide any significant support for the eurozone economy either, and given the high level of uncertainty, both as a result of the turning labour market and the political tensions in various member states, it is unlikely that consumers will come to the rescue. At least not in the first half of the year.
The prospect of tariffs on European goods and a possible escalation into a full-blown trade war is putting even more pressure on the economic outlook. After all, tariffs will be imposed - the only question is when and to what extent. Depending on how extensive the trade links with the US are, eurozone member states will be hit differently. The already struggling German automotive industry, for example, would be hit particularly hard. However, even worse is the fact that Trump's deregulation, de-bureaucratization and already lower energy prices in the US will probably additionally undermine Europe's competitiveness. The US is increasingly turning into a much more attractive business location, while structural weaknesses and political uncertainty at many of Europe's doorsteps are leaving Europe increasingly unattractive.
Due to the tense political situation in many European countries, a timely implementation of the necessary steps to deal with Trump economically appears unlikely. Accordingly, it will be the ECB that will initially do the heavy lifting. Even more, as the risk of a fully fletched trade war between Europe and the US, is additionally weighing on growth prospects. In light of the weak economic outlook - with more downside than upside risks – we expect the ECB to bring the deposit rate below the neutral level.
The best answer to Trump’s unpredictability, however, would be a clear attempt to strengthen the domestic economy with investments and reforms.