Intro

Our Global Head of Fixed Income and Thematic Research joins our U.S. Public Policy Strategist to give investors their policy expectations for President-elect Trump’s second term, including the potential market and economic consequences of those policies if enacted.

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's global head of fixed income and thematic research.

Ariana Salvatore: And I'm Ariana Salvatore, U.S. public policy strategist.

Michael: And on this episode of Thoughts on the Market, we'll talk about potential policy paths the second Trump administration might pursue.

It's Monday, December 23rd at 10am in New York.

The U.S. presidential election is behind us and we're well into the holiday season, but we're still focusing closely on what U.S. policy might look like in 2025. Ariana, what have we learned in the past couple of weeks regarding Trump's policy plans for next year?

Ariana: So the variables or policy items that we're watching are still the same ones that we were tracking over the past year or so. That's tariffs, taxes, immigration and deregulation. But to your point, the election is now obviously behind us, and we do have some incremental information that's helped us construct a base case across these variables. For example, President elect Trump has made some key personnel appointments that we think are going to play a big role in exactly how these policies are carried out. His pick for Treasury Secretary, Scott Besant, is a good example that gives us conviction in a more gradual, incrementalist approach to tariffs. Translating that principle across all the policy variables, as well as the extremely thin majority the Republicans have in the House of Representatives, has helped us form the foundation of our base case, which we call “fast decisions, slow implementation.”

In short, we think that means you should expect major policy changes will be announced quickly, think first quarter of next year, but achieved more slowly. That, in our view, enables more benign macro conditions to persist into 2025, but does create some more uncertainty, both positive and negative, into 2026. We think that lag is attributable to a variety of logistical, legal, and political constraints, and does vary depending on the policy area and executive authorities. For example, we think Trump might have an easier time unilaterally modifying tariff rates, but other constraints outside of timing might limit implementation nonetheless.

So, Michael, taking this a step beyond just the policy paths, how should investors be thinking about the potential market and economic consequences of our base case? Aside from the specific policy changes, how do you think about our base case in terms of broader market themes?

Michael: I think the key takeaway here is that the policy path we're describing puts pressure on economic growth, but on a lag. So most of these effects are for later in 2025 or into 2026 per economist expectations.  So I think the key takeaway here is that the policy path we're describing exerts pressure on economic growth, albeit on a lag. So in our economist expectations later in 2025 and into 2026. So what that means is as we go into 2025, there's still a pretty good growth backdrop to support risk assets and equities in particular. It's also a pretty good backdrop for bonds because as we get closer to 2026, our bond strategist expectation is that markets will start to reflect expectations of growth pressure. And they'll probably be less concerned about what's a debate right now, which is the size of U.S. deficits. There's been this expectation that policies extending tax cuts would really grow the deficit substantially in the way that might put downward pressure on bond prices.

However, we think when investors take a closer look, they'll see that extending current tax cuts, which is our expectations, basically, they'll be able to extend current tax cuts with a few sweeteners on top, that's mostly an extension of current policy, as opposed to some of the headlines in the news talking about major deficit expansion, that's an expansion relative to if Congress did nothing and just let tax cuts expire. So the year over year difference in deficits is perhaps not as big as some of the headlines would suggest. So that's a good backdrop for bonds and a pretty good backdrop for equities and risk assets, at least to start the year.

Ariana: But of course, there's a lot of uncertainty embedded in these policy paths. Can you talk through how we're thinking about potential risks to our base case, or maybe some key signposts that could indicate that other scenarios are becoming plausible?

Michael: So if there are policies that shift that growth downside sooner, so instead of it manifesting in 2026, it manifests sooner in 2025, that's the type of thing that might make us less constructive on risk assets and equities. So if we got indications, for example, that tariffs were going to be implemented more quickly and to a greater degree, for example, announcements happening quickly, but also showing implementation is happening very quickly, that's the type of thing that might skew risk assets in a more negative direction. Similarly, if Congress were to pledge to appropriate more powers to the executive branch on tariff authority, not necessarily something we think they could get done, but that could be an indication that there could be more powerful tariff potential relative to what the executive branch currently has.

On the more positive side, if Congress indicates that it wants to move much faster and bigger on tax cuts and the executive branch were to flag that tariffs are going to be implemented later or suggest that there's more negotiating room with trade partners to avoid tariffs, then that might be the type of sequencing of policy that enables the market to focus more on the good aspects of policy, the helpful aspects to corporate earnings, to individual consumption, and to GDP growth that might just make for an all around more conducive environment to risk assets.

So there's a lot to keep an eye on between now and inauguration day. In the meantime, enjoy your holiday. Ariana, thanks for taking the time to talk.

Ariana: Great speaking with you, Mike.

Michael: And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen, and share our thoughts on the market with a friend or colleague today.