13 risks that could affect markets as Trump takes office
20 JAN, 2025
By Stephen Auth
By Stephen Auth, Chief Investment Officer, equities at Federated Hermes
This year, after reviewing my list of upside and downside risks with my macro team, this list is described as the ‘12+1 risks, with an uptrend’. This is quite normal for a bull market, which needs a ‘Wall of Worry’ as essential fuel. Let us now review the risks on both sides. We highlight six to the downside and seven to the upside, making the package a 12+1, with an overall uptrend.
Downside risks
1. The unpleasant “sausage-making” of the President’s agenda could undermine post-election euphoria in the short term
There is already much negotiation underway, with plenty more to come. As the market hinges on the assumption of full implementation of Trump’s agenda, and with the entire agenda likely to be bundled into a single bill, this legislative process could be particularly unsettling in the short term.
2. Earnings might not materialise
Much of our market stance relies on corporate earnings confirming a robust annual growth rate of 12%, driven by strong economic growth, continued productivity gains partly boosted by AI, reductions in corporate taxes, lower operating costs due to the dismantling of the stringent Obama/Biden regulatory regime, and improved cash flows driving buybacks. However, there are numerous reasons why these earnings expectations might not be realised: tariffs could disrupt supply chains, tax cuts might be scaled back in the omnibus bill, interest rates could remain high for longer, and so on. We’ll be keeping a close watch during the first-quarter earnings season, which is nearly here. The tone and guidance from these reports—both for big tech and the broader market—will be more critical than usual.
3. The Fed might make (another) policy mistake
So far, Powell’s Fed hasn’t exactly inspired confidence in some quarters. They were late to start the rate hike cycle in 2022, underestimating how persistent supply-driven inflation was, which led to a series of 75-basis-point hikes that nearly derailed the economy. Last summer, they were also late to begin the rate-cutting cycle, belatedly enacting 100-basis-point cuts in the second half of 2024, which briefly softened the labour market. Their reliance on backward-looking economic models designed for idealised academic scenarios, rather than real-time inputs, tends to leave Powell’s Fed in reactive mode, increasing the risk of further errors. Our current concern is that they may keep rates too high for too long, given inflation seems to be hovering between 2.5% and 3.0%, while the federal funds rate is currently 150 to 200 basis points above this range. Worse, they could panic over a poor inflation reading and hike rates further, triggering a sharp sell-off in equities.
4. The exhaustion of massive demand-side stimulus from Biden’s policy agenda could create too large a short-term void
Speaking of the $7 trillion in what was largely unnecessary fiscal stimulus under Biden’s tenure, a key question is what happens when this stimulus runs out.
5. US bonds could face a "Liz Truss moment"
While the US is not the UK, any misstep in omnibus negotiations or an unexpected inflation spike could prompt a bond market reaction, pushing yields above 5.0%. If that happens, expect equity sell-offs.
6. The incoming administration’s overconfidence could lead to overreach
Whenever one party wins big in our democracy, it often succumbs to the natural human tendency toward hubris. The good news is that Trump has been through the political wars before and is likely well aware of the risks of overreach. However, there’s still potential for missteps—whether by letting the debt ceiling blow up, allowing a trade war with China to spiral out of control, or allowing a fiscal stalemate to trigger automatic tax hikes that choke off growth.
Upside risks
1. The omnibus “Trump Agenda” bill passes ahead of schedule
If the President can galvanise Republicans effectively and if Musk’s promised DOGE initiative gets off the ground as discussed, it’s possible that much of the pro-growth agenda could be implemented by spring. If so, markets would likely surge.
2. “Tariff chess” could play out better than expected
In a bullish scenario, negotiations could exceed expectations, proving not just neutral but actually positive for the US economy.
3. Inflation falls, and the Federal Reserve adopts a firmer monetary stance
Any surprise decline in inflation could drive markets upward. There are reasons to believe this might happen. First, there’s a statistical base effect from the early months of 2024. Second, a peace agreement in the Middle East, coupled with eased federal restrictions on LNG and oil production, could lower oil prices and inflation. Third, the overheated rental market might cool as new supply comes online.
4. The IPO/M&A market heats up
With a more business- and corporate-friendly regulatory regime in the pipeline, we expect that after four years of stagnation, capital markets for IPOs and M&A could pick up quickly, driving valuations higher.
5. Geopolitical risks in Ukraine and the Middle East ease
With Trump back in office and a steadier hand overseeing US military operations, it’s possible that the “intractable” wars in Ukraine and the Middle East could finally come to an end.
6. The DOGE movement could go global
On my recent trip to Europe in December, the sentiment abroad was markedly different from the Trump presidency’s earlier years. Instead of asking, “How can you vote for this man?” the general sentiment seemed to be, “We wish we had someone like him.” The US is not the only G7 economy hampered by excessive regulation and overreaching central governments; in fact, things are arguably worse abroad, particularly in Europe’s ailing economies. With elections approaching in Germany, we could even see a sudden pivot towards pro-growth policies in the most unexpected of places—continental Europe.
7. The dollar could start to soften
A weaker dollar could be triggered by any of the upside risks mentioned above. Since negative net exports are a direct drag on GDP growth, a reversal in this trend due to a weaker dollar would boost both US GDP and corporate earnings. Equities would likely react positively.
