The US elections ended with a surprise ‘red sweep’ of the presidency, Senate and House, with Donald Trump winning the electoral college and also the popular vote. Emboldened by this clear mandate, Trump and his team have the potential to disrupt the political arena and global markets. This could take the form of tariffs, restrictions on migration, tax cuts and aggressive deregulation, all done in a way that might be more than willing to break with established norms and conventions. The addition of a group of ‘techno capitalists’, including Elon Musk, to the core team has the potential for further surprises.

Risk assets have taken a sanguine view and seem to be focusing more on the positive sides of a Trump 2.0 presidency. A big part of that is certainly related to the experience of the first Trump term, which was overall positive for markets. This was despite the fact it was quite disruptive, as it gave a big boost to global protectionism, stepped up significantly the US’s stance against China and put into question strategic alliances that have been a cornerstone of the post-second world war order, such as Nato.

Post-election, markets’ reactions have been broadly similar to the 2016 ‘Trump trade’: stocks up, dollar up and expectations of higher growth. However, the impact of Trump 2.0 is going to be more complex because it is happening in a very different economic and geopolitical environment, especially given the broad mandate that was given to Trump and the Republican party.

Is the market right in its optimism when it comes to the investment implications of a second Trump presidency? Is the soft landing baseline scenario at risk given the policies announced by Trump during the campaign? What are the implications for Europe, China and other economic blocks?

Optimism about US growth

Trump will take over an economy that is overall in a good shape. Growth has slowed down, but the likelihood of a recession remains low. Unemployment remains at the lower end of historical ranges and labour markets have now normalised after Covid-19-related distortions. Inflation remains slightly above target but has fallen enough that it allowed the Federal Reserve to ease interest rates and to bring real rates to a more neutral position. But the most notable difference with Trump 1.0 is that the US appears to be in a late cycle phase of the post-Covid-19 recovery.

The positive market view about Trump 2.0 rests on the assumption that deregulation, tax cuts, ramped up energy production and more efficiency on the public expenditure side will prolong and eventually reinforce the current US growth cycle. The artificial intelligence revolution is in full swing and its impact on productivity could become visible during Trump’s next term as the adoption of digital technologies spreads across the corporate and financial sectors.

In contrast to other regions – Europe dealing with political uncertainty and stagnant growth, and China facing deflation and tariffs – Trump 2.0 could make US exceptionalism a more enduring trend. As declared by newly appointed Treasury Secretary Scott Bessent, Trump 2.0 has the potential to unleash a ‘new economic golden age’ for the US.

Offsetting the negative impact of policies

Markets’ optimism over Trump 2.0 also rests on the belief that the positive impact of these policies will more than offset the negative impact arising from announced policies on tariffs and immigration. It reflects a widespread view among investors that the most controversial policies around tariffs and foreign policy are just ‘negotiation tactics’ of an entrepreneur-turned-politician who has a ‘transactional’ view of international political relations.

There is still a lot of uncertainty about deportations and the magnitude of Trump’s immigration policy. The private sector opposes strong cuts in immigration flows as this could lead to damaging labour shortages. International experience also shows that anti-immigration politics help to win the elections but rarely translate into significant drops in immigration flows.

Markets are often short-sighted and take their time to capture deeper structural changes. However, some trends are already visible and could lead to a market backlash later in 2025 and 2026. They concern: the shifting interest rate outlook, public debt sustainability and long-term bond risk premia, and the potential for tariffs to lead to a prolonged confrontation with trade partners and spillovers with negative effects on exchange rates.

On interest rate policy, the Fed has already signalled that it will take a more cautious approach to cutting rates as it waits for more detail about the policies announced by the Trump administration, many of which are perceived as inflationary.

Reducing consumer prices and protecting the purchasing power of households has been one of the most important electoral promises. Should inflation remain well above 2% or go even higher as Trump 2.0 policies are unleashed, a prolonged period of higher-than-expected policy rates could slow down the US economy and eventually lead to a more direct confrontation between the Fed and Trump.

Fiscal priorities amid rising protectionism

On the fiscal side, extending tax cuts will cost nearly $5tn, with a significant impact on debt sustainability. Tariff revenues might provide some fiscal cushion but will be highly sensitive to the level at which they will be imposed. The drop in global demand caused by rising protectionism makes the revenue potential of tariffs very uncertain.

Bond markets already reacted negatively after the election with a continuation of the upward trend in yields that started after the September Federal Open Market Committee meeting. US 10-year yields are now close to 5%, up from 3.6% at the end of last summer. While this rise in long-term yields started when Trump was not yet the favourite in the polls and also reflects the more prudent monetary policy stance taken by the Fed, it might well be that markets have started to build risk premia attached to US Treasuries as concerns over debt sustainability rise.

Ten-year yields above 5% would be bad news for the real economy, impacting households’ consumption via mortgage rates as well as corporate investments. Eventually, the fiscal policy priorities will have to shift from tax cuts to fiscal consolidation, ending years of loose fiscal policy.

Dollar strength

In this context, the current strength of the dollar is supported by interest rate differentials and stronger growth expectations. Trump has made no secret of the fact that he aims for a weaker dollar to boost US exports, and rising geopolitical tensions are likely to promote more diversification across currencies.

One factor that could impact the appetite for dollar-denominated assets, in particular government bonds, is whether Trump will further broaden the so-called weaponisation of the dollar to achieve geopolitical goals.

During the election campaign, Trump also made remarks about the potential use of tariffs or sanctions against countries that are attempting to replace the dollar for other currencies in international trade; a threat that is likely to accelerate diversification away from the dollar. Therefore, extensive use of the dollar as a geopolitical tool by the US administration is a risk that can no longer be neglected. But combined with rising concerns over debt sustainability and rising bond risk premia, there is the risk of a toxic environment for the dollar over the medium to long term.

Finally, the international community has taken a wait-and-see approach until there is more clarity about the full set of measures that Trump will pass, and their conflicting influences on growth and international relations. Should Trump’s policies turn out to be as radical and disruptive as feared, retaliatory measures will be envisaged, including the possibility of using exchange rates as a tool to counteract tariffs.

At that point, investors will closely watch to what extent the second Trump term is going to focus on achieving longer-term ideological goals aimed at shifting the power between US labour and capital, and re-defining international relations with allies and adversaries, even if it is detrimental to asset returns, which were an important benchmark for Trump during his first term.

Should markets start to worry that there might be much less of a self-correcting feedback loop between disruptive policy proposals and market moves, the honeymoon between markets and Trump 2.0 could end sooner than many expect.