Macro Signposts | 5 November 2024
This week, I asked Libby Cantrill, PIMCO's head of public policy, to coauthor Macro Signposts and discuss policy uncertainties that could shape the U.S. economy.
Key Policy Questions Likely to Linger After the Election
By Tiffany Wilding and Libby Cantrill
Long after the U.S. election results are tallied, questions will linger around the likely economic impact of the next president's policy priorities.
In some areas, the outlook is clearer: We can expect deficits to increase, the 2017 tax cuts to be (mostly) extended, U.S.-China tensions to continue, and the Federal Reserve to remain independent.
That said, the practical details of fiscal and foreign policy will take months or more to unfold. Also, narrow congressional majorities will likely limit the scope for sweeping partisan change - potentially making some campaign rhetoric ring hollow.
Not just policy priorities, but the implementation of those priorities (including the right personnel to drive them forward) will be critical in the months ahead.
Here are three key policy uncertainties that could have a significant impact on the U.S. economy regardless of who is in the White House.
Deficit and debt
We've argued that the longer-term deficit is going to remain on an unsustainable path no matter who wins, so questions and concerns about the fiscal trajectory won't diminish. The Congressional Budget Office (CBO) forecasts the U.S. debt-to-GDP ratio could climb above 200% over the next several decades, largely due to the combination of an aging population and the government safety net programs (including Social Security and Medicare) that neither side seems keen to address.
Meanwhile, longer-term interest rates in the U.S. (measured by the 5-year, 5-year forward interest rate, which as of this writing was 4.5%) are getting very close to nominal GDP trends - 2% real growth and 2%-2.5% average inflation - a threshold where debt levels can spiral. Economic theory indicates that government debt is sustainable only when the average effective interest rate on the debt ("r") is less than average nominal growth rates ("g").
Fortunately, the U.S. government still has a lot of lower-coupon outstanding debt, and the effective average nominal interest rate it pays (roughly 3%) is still lower than estimated nominal potential growth rates, and market rates. However, if long-term market interest rates stay at the current level, effective interest rates could increase to concerning levels over the next decade, or sooner if rates rise further from here, with higher trend growth rates.
Taxes
Against these big questions around the longer-term debt outlook, tax policy legislation will be in focus in 2025, when many of the 2017 Tax Cuts and Jobs Act (TCJA) provisions will expire. The net outcome of the extensions and pay-fors can only become clearer as we move through 2025.
The CBO estimates the 10-year cost of the TCJA provisions - if made permanent - at around $4.5 trillion. We expect many of the provisions will be extended. Although the details are still murky, there are likely to be at least some pay-fors - perhaps corporate tax rate increases or tariff revenues - that will create sector and income level winners and losers.
Furthermore, these tax changes aren't happening in a vacuum. The broader economic environment has historically influenced fiscal policy decisions. The extent to which a strong economy can garner higher pay-fors is a big question mark this legislative cycle.
Trade
With broad-based agreement across the political spectrum that China's trade practices are detrimental to the U.S., but with wildly different views by party on how to address the issue, trade uncertainty is also likely here to stay.
Many Republicans are advocating broader and more aggressive trade policy proposals than President Joe Biden's "small yard, high fence" approach. Such proposals, if fully implemented, could be globally disruptive, with potentially large implications for currencies. But how much of this rhetoric is simply a negotiating tactic to gain leverage for more reciprocal trade, versus a genuine preference for outright decoupling? Democrats have focused on building a global coalition against Chinese trade practices, which is also likely to alter global trade patterns.
How these policies interact with policies in other economies is another key question. Large swings in the U.S. dollar could have meaningful implications for emerging markets and for monetary policy.
China's own domestic policy priorities will also be important. Weakness in the Chinese economy, stemming from the ongoing property sector contraction and weaker consumption, has recently spurred a barrage of monetary policy announcements seeking to stabilize output. Many analysts also expect to see more stimulative fiscal policies as well, given the lessons from Japan in the 1990s and the U.S. after the 2007 housing bubble burst: During periods of deleveraging, the efficacy of monetary policy has tended to decline.
However, the extent and timing of China's policies will likely depend on how U.S. trade policy evolves, creating an environment where U.S.-driven disruption to the global trade order spurs counteracting stimulative measures elsewhere.
Interestingly, China isn't the only country with potentially looser fiscal policy. Recent developments in the U.K. and Japan have also moved in that direction.
Navigating uncertainties
Overall, post-election policies are likely to present economic tailwinds and headwinds. Tax cuts and extensions could support near-term growth, but the deficit is the loser regardless of the election outcome, raising more questions about the U.S.'s longer-term fiscal sustainability. U.S. trade policies to combat what the U.S. perceives as unfair practices have the potential to alter global activity, and potentially usher in a wave of additional policy support from other governments.
Over time, as today's policy uncertainties gradually shift into probabilities and then into realities - which may raise new questions - the U.S. (and global) economic outlook could shift notably through 2025 and beyond. Meanwhile, elevated uncertainty around future policy continues to affect decision-makers today, from the Federal Reserve to businesses to communities and families.
Upcoming webcast: "Insights on the Evolving U.S. Investment Landscape"
Please join us for an analysis of the investment implications following the U.S. elections and the latest Federal Reserve meeting. PIMCO's Group CIO Dan Ivascyn, Head of Public Policy Libby Cantrill, and Global Head of Product Strategy Kim Stafford will discuss emerging opportunities and risks across financial markets and how we're positioning portfolios.
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