Corporate tax cut to 15%

Reducing the corporate tax rate from 21% to 15% is a cornerstone of Trump’s economic agenda. This policy aims to boost U.S. business competitiveness and stimulate capital investment. By lowering tax liabilities, corporations retain more profit, which can be reinvested in growth initiatives, such as R&D, capital expenditures, and productivity improvements.

• Growth impact: Lowering the corporate tax rate from 21% to 15% is expected to provide a modest boost to real GDP in the short term, as businesses increase investments in capital and productivity. This reduction could lift GDP growth by up to 0.5% in 2025, resulting in potential real growth of 2.5% - 2.75%.
• Inflation: The stimulus effect could modestly increase inflation due to demand pressures, although the primary inflationary effects are likely to be contained if growth remains within potential output.
• Supply impact: The tax cut could reduce corporate tax revenue, increasing Treasury issuance needs by $200 - $350 billion to fund deficits.

Broad-based tariffs: China, Europe, and global imports

Tariffs on imports from China and Europe (up to 50-60%) and a potential blanket 10% tariff on all imports aim to boost U.S. domestic production but could disrupt supply chains and raise input costs.

• Growth impact: Tariffs could dampen U.S. economic growth by increasing the cost of imported goods, with an estimated reduction of growth by 0.4% - 0.6% by 2026. Retaliatory tariffs may impact U.S. exports, further affecting growth.
• Inflation: Projected increase in Core PCE inflation by 1% - 2.5%, adding cost-push inflation across goods sectors. Recent exit polls suggest that the GOP’s focus on inflation resonated strongly, highlighting the impact inflation has on consumer sentiment and political outcomes.
• Treasury market impact: The increased inflation risk from these tariffs could lead investors to demand a higher term premium on Treasuries as compensation for holding assets in an inflationary environment. Additional Treasury issuance, estimated at $150 - $300 billion to fund the broader fiscal deficit, would likely be required as the government faces reduced trade revenue and increased borrowing needs.

This broader tariff approach, if implemented, would have widespread effects on the U.S. economy, introducing both inflationary pressures and a drag on growth, which could impact the Fed’s rate decisions and contribute to higher Treasury yields.

Three primary scenarios emerge for the 10-year Treasury yield, with varying implications based on inflation expectations, changes in term premiums, and Federal Reserve responses.

Scenario 1: Rise in yields (4.75% - 5.25%)

• Probability: 35%

In this high fiscal expansion scenario, aggressive tax cuts and increased spending on infrastructure and defence drive a deficit increase of $800 billion to $1 trillion. The likelihood of this scenario reflects a strong fiscal policy push by the administration to stimulate growth, potentially pushing issuance needs to an additional $500-$750 billion. This rise in issuance, coupled with inflationary effects from both demand-side stimulus and tariff impacts, justifies the anticipated yield increase.

Detailed breakdown:

• Growth and inflation impact: Projected real growth could rise to 2.50-2.75% in 2025, with inflation climbing to 2.8%-3.1% by 2026 due to tariffs, reduced labour supply and demand pressures.
• Term premium: With increased Treasury issuance to fund the deficit, investors may demand a term premium of 0.30% to 0.40% as compensation for inflation and heightened supply risk.
• Fed policy response: The Fed may pause or halt rate cuts to manage inflation expectations. A more hawkish stance could counteract rising inflation, pushing yields higher.

Projected yield: Under these conditions, we project the 10-year Treasury yield to reach 4.75% - 5.25%.

• Higher issuance, inflationary effects from fiscal stimulus, and tariff-induces price pressures would likely drive yields up.
• Demand factors: Despite issuance pressures, structural demand factors (foreign interest, institutional demand, and safe asset status) may cap yields, making a rise above 5.25% unlikely.

• Expected return: Given this yield increase, the total one-year return would likely be around -1% on average, as the price decline largely offsets the coupon income.

Scenario 2: Stabilisation in yields in the range of [4.20% - 4.70%]

• Probability: 40%

This moderate fiscal expansion scenario involves a controlled approach to spending and tax cuts, aiming to balance stimulus with fiscal responsibility. The anticipated increase in the deficit—$250-$500 billion, with additional issuance of $100-$250 billion—is expected to be manageable, leading to minimal inflationary pressures. The balanced nature of this approach, combined with global demand for U.S. Treasuries, supports stable yields within this range.

Detailed breakdown:

• Growth and inflation impact: Modest spending growth would have a minimal impact on inflation, which remains manageable within the Fed’s inflation target. GDP growth remains at 2.2%-2.4%.
• Term premium: With a limited issuance increase, the term premium adjustment would likely be minor (~0.10%).
• Fed policy response: The Fed would likely maintain a neutral stance, with minimal adjustments to its rate-cutting path, assuming inflation remains steady.

Projected yield: We expect the 10-year Treasury yield to stabilise around 4.25% - 4.75%.

• Moderate inflationary impact from controlled fiscal spending would support a stable yield environment, with the Fed likely maintaining a neutral stance on rate cuts.
• Demand factors: Strong global demand for Treasuries due to yield differentials and currency benefits for foreign investors, alongside resilient domestic demand from pension funds and insurers, reinforces stability within this range.

• Expected return: In this scenario, the one-year total return would be approximately 4.0% on average, reflecting stable yield conditions with no significant price impact.