Lame-duck Trump era brings uncertainty to global markets

The global economy faces significant uncertainty as Donald Trump enters the final two years of his presidential term without control of either the House of Representatives or the Senate. Following the midterm elections, where Democrats secured decisive victories, analysts warn that a highly erratic lame-duck president will have profound effects on financial markets, growth, inflation, and government borrowing costs.

Initial market reactions to the election results were mixed. While stock prices dropped during early trading in Asia overnight, they subsequently rallied as investors assessed the political landscape. Market participants generally dislike political chaos, so Trump’s concession and his acknowledgment of the impact of the Iran war were viewed positively. However, his declaration that he would become Mr. Veto has raised concerns about a turbulent conclusion to his time in the White House.

Holger Schmieding, chief economist at Berenberg, noted that the results indicated US voters had rejected Trump and his preference for crony capitalism. He argued that this outcome demonstrates that US institutions and checks and balances are functioning effectively, which he considers a positive development. Nevertheless, the broader outlook for markets, inflation, and growth remains heavily dependent on the ongoing war in the Middle East and the pace of artificial intelligence advancement.

Inflation has become a central concern for US households, driven by a chaotic tariff policy and the unpopular war. Diesel prices hit record highs in August, pushing the headline inflation rate to 3.7%. The US-Israeli invasion of Iran and the subsequent closure of the Strait of Hormuz reignited global inflationary pressures, creating the largest energy price shock of the modern era. Although oil prices have eased due to hopes for diplomacy, Brent crude remains above $100 a barrel, well above its prewar level of approximately $70.

The International Monetary Fund now projects that global headline inflation will reach 4.7% this year, with energy-importing nations facing the hardest hit. If Trump escalates hostilities against Iran, the inflationary shock could worsen, though such a move would likely further increase his unpopularity. Higher inflation has forced central banks to act, with the US Federal Reserve raising interest rates for the first time since 2023 despite pressure from the president.

Investors anticipate at least one more rate hike from the Fed, while the Bank of England and the European Central Bank are also expected to increase borrowing costs. With Republicans lacking the votes to confirm new appointments to critical public bodies, including the Fed, Trump may rely on his veto power to maintain influence, a power that can only be overturned by a two-thirds majority in both chambers of Congress.

Government finances face mounting pressure as higher borrowing costs strain nations with significant public debt. The US political system will face its first major test on 11 December when politicians must authorize government spending to avoid a shutdown. This gridlock could limit Trump’s ability to launch new tax and spending measures, potentially restricting fiscal stimulus while also curbing further increases in national debt.

Analysts suggest that the crushing defeats for MAGA candidates may weaken the president’s authority, paving the way for greater cooperation between Republicans and Democrats. Regarding economic growth, political turbulence and actions on trade and immigration pose risks to the US economy. However, inflation and the prospects for de-escalation in the Middle East remain the primary factors for investors to monitor.

There is growing wariness among investors that a Democratic clampdown on AI regulation could impact investment and growth. The spillover effects of the tech boom have been felt globally, helping to bolster the UK economy. However, tech leaders are already cooling on AI rollout due to cyber risks, and many investors fear a bubble in the US stock market. Analysts at Allianz note that the scale of AI investment may make the traditional left-right political playbook less predictable, with environmental and social impacts becoming increasingly important considerations.

As recently as last month, the IMF forecast that US growth would remain stable at 2.3% for this year and next, despite risks from the Iran war and uncertain AI investment paths. In contrast, analysts at Berenberg predict that US growth could slow to about 1.5% in 2028 due to political gridlock, a slowdown in AI, and the drag from Trump’s immigration crackdown. Consequently, the US is expected to contribute less to global growth than it has in the past.