Recession risk rises after Trump victory: BCA

Investing.com -- BCA Research has raised the probability of a US recession from 65% to 75% in the wake of former President Donald Trump’s recent electoral victory.

While Trump’s agenda includes elements favorable to business, BCA notes these are overshadowed by the risk of an escalating trade war, which would likely weigh heavily on corporate investment and disposable household income.

Among the key factors driving BCA’s revision is the bond market. Bond yields surged in anticipation of Trump’s win, but the firm argues that this cannot be justified by expectations of stronger GDP growth, pointing to the limited effect of Trump’s previous corporate tax cuts on capital spending.

Furthermore, a potential trade war under Trump is expected to dampen corporate investment, further weighing on the growth outlook.

“The prospect of a new trade war more than offsets the other pro-business parts of Trump’s agenda,” BCA’s note states. “With the labor market already weakening going into the election, the odds of a recession have risen.”

BCA’s analysis indicates that while Trump’s proposed corporate tax cuts could theoretically provide a modest boost to S&P 500 earnings, the impact is likely minimal compared to potential downsides.

Specifically, the firm believes that a reduction in the corporate tax rate from 21% to 15% could lift S&P 500 earnings per share (EPS) by just 4%, which is less than the S&P 500’s gains just in the past week. Also, the anticipated effects of heightened tariffs and reduced global trade could pose a significant drag on earnings, with Barclays (LON:BARC ) estimating that a 60% tariff on Chinese imports and a 10% tariff on imports from other countries would lower S&P EPS by 3.2%, or even 4.7% if retaliatory tariffs are enacted.

These headwinds, alongside potentially reduced capital expenditures, could weigh heavily on overall market performance.

Meanwhile, the Federal Reserve continues to face a challenging policy environment. Conventional central bank wisdom would suggest looking past any inflation spike due to tariffs. However, BCA points out that, after being caught off-guard by pandemic-induced inflation, the Fed might be less willing to do so, potentially leading to tighter monetary policy.

“Having been so badly burned by the whole “transitory” narrative, our guess is that the Fed would be initially circumspect in cutting rates for fear that another rebound in inflation could unanchor inflation expectations,” said BCA strategists led by Peter Berezin.

“This could potentially exacerbate the economic downturn,” they added.

Fiscal policy under Trump also raises red flags. While he has proposed lowering corporate tax rates further, BCA emphasizes that the federal debt is likely to increase sharply due to various tax cuts and expanded government spending, with projections estimating an additional $5.35 trillion added to the debt over the next decade in a central scenario.

Meanwhile, the labor market, despite appearing resilient, is also showing signs of weakening, with a decline in job openings and a notable increase in unemployment claims According to BCA, immigration policies under Trump may further tighten the labor supply.

Source: Investing.com