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As Donald Trump embarks on the U.S.'s first non-consecutive second presidential term since Grover Cleveland did so in 1893, a number of his proposed policies—including those on trade, taxes, and immigration—could have direct, profound effects on the economy and credit conditions.

What We're Watching

The ramifications of the president's plans—even if only partially effected—will range across the spectrum of issuers we rate. U.S. corporate borrowers, financial institutions and insurers, structured finance, and states and municipalities can all expect to see some ramifications from the new administration's approach.

With the caveat that there are often stark differences between campaign rhetoric and implemented policies (causing significant uncertainty around our forecasts), the areas with the potential to have the largest effects on the economy and credit are trade/tariffs, taxes, immigration, and regulation.

In the hours after his inauguration, the president signed a flurry of executive orders, including many designed to (among other things) restrict the flow of immigrants into the U.S.—particularly those from Mexico. On the campaign trail and in the aftermath of the election, he has also promised or threatened to levy materially higher tariffs on a number of the country's trade partners.

President Trump inherits a resilient economy that has largely outperformed its peers in recent years, with GDP growth that is easing into an ever-elusive soft landing. Following an expansion of an estimated 2.7% last year, we forecast the world's biggest economy to grow 2.0% in each of the next two years—factoring in partial implementation of the president's suggested tariffs and reciprocal responses from the U.S.'s trade partners, as well as tighter immigration standards. Also implied in our forecast is that the personal tax cuts in the 2017 Tax Cuts and Jobs Act (TCJA) will be extended for 2026 and beyond.

What We Think And Why

In our macroeconomic base case, we assume President Trump will use his executive powers to impose targeted tariffs on China by raising the bilateral effective tariff rate (weighted average) on Chinese imports to 25%, from the current estimated 14%. While an announcement may come within the first 100 days in office, our assumption around implementation is that levies are likely to begin midway through this year, giving businesses time to plan. We also expect Beijing to answer with equivalent higher trade barriers on U.S. exports to China.

Beyond our base case, President Trump has threatened across-the-board levies on China as high as 60%. This extreme (albeit unlikely) scenario would strike a heavy blow on the Chinese economy and on an array of industries that rely on U.S. exports. We estimate that China's exports of goods and services would tumble 10% by 2026, compared with our current baseline estimate. Chinese investment would fall 5.5% as industrial production weakened sharply and spillover effects kicked in. The shock would drag down the level of China's GDP around 5% below our baseline forecast by 2026. Imports would also fall, but much less than exports.

From a U.S. macro and credit perspective, increasingly protectionist trade policies and subsequent international responses will likely result in inflationary pressures through higher input costs for companies and higher prices for consumers. This could add to pressures on profit margins for some corporate sectors, hamper financial market access, and further accelerate supply-chain diversification away from China.

In the near term, the ongoing strength of the economy and the prospects of resurgent inflation could force the Federal Reserve to stall—or even reverse—its easing of monetary policy. As it stands, we think the central bank will reduce the federal funds rate more gradually than what we had considered in our September forecast and reach an assumed neutral rate of around 3.1% by the fourth quarter of 2026.

The fate of some of the TCJA's corporate tax provisions—such as interest deductibility, bonus depreciation, and deductions for research and development (R&D) expense—will be in the spotlight. There has already been a legislative proposal to permanently extend the tax treatment that expires this year; given the election outcome, we believe these tax deductions will be made permanent. Our baseline assumes the Republican-led Congress will also extend the TCJA's personal tax cuts.

From a corporate standpoint, the extension of the above tax deductions beyond this year, particularly if done retroactively, would generally be a benefit to net income and boost post-tax cash flow. Changes in deductibility of interest expense and R&D expense would lead to lower outflow for taxes, thereby increasing funds from operations (FFO). Lower cash outflow would also add to the cash available to service debt, all else equal.

However, the erosion of purchasing power from higher prices would likely outweigh the economic benefits of the proposed tax cuts, resulting in a net drag on economic output and job creation.

For immigration, our base case assumes that the net flow of migrants will gradually fall back to the 2017-2019 average over the next two years. This would be a headwind to economic growth as the labor supply, which rose 1.6% on average in the past two years, slows sharply.

Immigration is the primary reason aggregate demand and aggregate supply both have surprised on the upside. It has helped U.S. GDP to grow at close to 3% while allowing for labor market tightness to recede.

The new administration's push to crack down on illegal immigration, as well as plans to curb legal immigration, will sharply—and quickly—reduce U.S. population growth. As a result, the economy's growth capacity could decline by as much as half a percentage point, compared with the past two years, absent increases in labor productivity growth and the employment rate of working-age Americans.

Lower net immigration will hurt most those sectors where immigrants account for a large share of the workforce, such as construction, hospitality, and agriculture. While we suspect there is scope for the employment rate among the U.S.-born workers to climb, it's unlikely that an increase will offset the drag from slower immigration, given the economy is already operating near full employment.

At the same time, changes in the federal immigration policy could put financial pressure on some public finance sectors—as slowing economic activity would exacerbate any incremental declines in tax revenue generated by immigrants' economic contribution, such as sales taxes. However, states and local governments could spend less on services, including health care, housing, and education, if vulnerable populations decrease as a result of immigration policies.

With respect to regulation, one area to keep an eye on concerns financial services, especially given the president's latitude regarding agency appointments and regulatory philosophy.

We expect leadership at several agencies to transition, but while the supervisory approach may change, our base case is that bank regulation won't loosen significantly. However, the administration and new regulatory leadership may consider changes to several areas, and the timeline for implementing changes in regulation on capital, liquidity, and other requirements could be extended.

What Could Change

Our baseline U.S. economic forecast doesn't incorporate potential tariffs on Canada and Mexico—the country's two biggest trade partners (followed by China). But, in comments shortly after taking office, President Trump suggested he could slap 25% tariffs on imports from its nearest neighbors, perhaps as early as Feb. 1. However, the consensus is that the two countries could avoid any tariffs by presenting credible plans to reduce the flow of immigrants and illegal drugs into the U.S.

More broadly, we don't anticipate material changes to the United States-Mexico-Canada Agreement (or USMCA, which President Trump himself signed into law during his first term, in January of 2020) before its scheduled review in 2026. However, we do expect the uncertainty surrounding potential changes to trade policy to affect investment.

Lower investment is reflected in our baseline economic forecasts for Mexico and Canada, where we expect GDP growth of 1.2% and 1.7%, respectively, this year. That said, if new tariffs were to be put in place, or material changes to the USMCA take place before its scheduled revision, this could weigh heavily on economic activity for both countries. In such an event, to assess the impact of the tariffs on our baseline forecast we would need more details, including the duration of the tariffs, sectors targeted/exempted, among others.

Perhaps most directly, trade barriers with Mexico and Canada pose the biggest risk for mass-market carmakers. U.S. automakers Ford and General Motors maintain meaningful production footprints in Mexico, due to lower labor costs, favorable trade agreements (especially the USMCA), and the proximity to the U.S. market.

Goods from Canada and Mexico account for 28% of all U.S. goods imports (12-month rolling sum through November 2024), while exports to these two neighbors make up 33% of all American exports. And while these figures may overstate actual demand because some goods cross borders multiple times as part of the complex supply chain, the threatened tariffs would chip away at U.S. manufacturers' competitiveness.

As it stands, U.S. manufacturers have limited scope to substitute for goods imported from Canada and Mexico. Some U.S. demand may eventually shift to domestic sources, but most of it is going to be reflected in higher prices. Carve-outs and any depreciation of the Canadian dollar and Mexican peso vs. the U.S. dollar would lessen the damage on the import side, but American exports would then be less competitive.

Mexico and Canada account for a significant share of energy, food, and vehicle trade—and price increases on these goods could prove politically unpopular. Canada is the also largest export market for the U.S. and makes up one of the smallest trade deficits. (The trade deficit with Canada is largely due to U.S. demand for energy-related products.)

The U.S. imports near 24% of the crude oil that gets through its refineries from Canada (of which 84% goes toward domestic consumption), so a 25% tariff would push up average U.S. crude prices by 5% and have a measurable effect on gasoline prices. In addition to pushing up auto prices, as well, higher lumber prices would raise the cost of building new homes—which would be passed on to buyers.

All of this adds up to headline inflation running hotter than our current projection, perhaps so much so that the Fed halts its easing of monetary policy even as economic growth suffers. Against this backdrop, investors could demand higher risk premiums, with financing costs remaining overly burdensome for some borrowers, especially those at the lower end of the ratings spectrum.

Writers: Joe Maguire and Molly Mintz