The Federal Reserve's big trouble: After the election, all roads lead to inflation!

The Federal Reserve's persistent efforts to combat inflation over the past two years are likely to be in vain due to the outcome of the US presidential election.

With supply chain issues being resolved and the Federal Reserve continuing to raise interest rates, US inflation is steadily declining. The year-on-year growth rate of CPI in September has dropped to 2.4%, approaching pre-pandemic levels. However, whether inflation will continue to ease next year largely depends on the outcome of the November election. If inflation rises again, the Federal Reserve will be forced to abandon its current rate-cutting strategy and resume raising interest rates.

Immigration, tariffs, and deficits are all big troubles

Legendary investor Paul Tudor Jones previously warned in an interview with the media that whether Trump or Harris wins the presidential election, US inflation will rise—both presidential candidates are making "crazy" promises of tax cuts and increased fiscal spending, turning a blind eye to America's deficit problem.

Nick Timiraos, a well-known financial journalist known as the "New Fed News Agency," stated in an article on October 28th that economists are generally more concerned about Trump than Harris. Market concerns are mainly focused on his trade and immigration policies, where the president has greater freedom of action and does not need congressional approval.

In terms of immigration, a study by the Peterson Institute estimates that deporting illegal immigrants (a core Trump policy) will significantly reduce economic output while pushing up inflation. Due to the decrease in labor force, businesses either raise wages and prices or accept a decline in profit margins.

Deporting immigrants may not achieve Trump's policy goal of shifting jobs from foreigners to Americans.

Research from the University of Denver in Colorado shows that for every 1 million illegal immigrants deported, 88,000 American workers become unemployed. This is mainly because immigrant workers in certain industries such as food processing, agriculture, construction, and hospitality are not necessarily competing with American workers.

If existing workers are deported, these companies may reduce production instead of hiring more local workers. The decrease in sales, in turn, leads to a reduction in high-paying jobs that American workers are engaged in, which are essential for these industries.

Market opinions are generally consistent on the consequences of Trump's tariffs policy. Business leaders and economists unanimously believe that US consumers will bear the cost of tariffs.

Philip Daniele, CEO of the US auto parts chain brand AutoZone, clearly stated during last month's earnings conference call, "will pass these tariff costs on to consumers."

The deficit issue is also a focus of market attention. In terms of taxation, Trump currently hopes to extend certain provisions of the 2017 tax cut law that are set to expire after 2025, while further reducing the corporate tax rate. He also proposes to eliminate taxes on worker tips, overtime pay, and retirement benefits for retirees.

This makes balancing fiscal expenditures an urgent problem that needs to be addressed. Paul Tudor Jones warns that if the next president does not adjust policies to reduce the deficit in response to the rising debt-to-GDP ratio in the US:

The solution to break free from this situation is inflation.

Fed fears pausing rate cuts and resuming hikes

For the Federal Reserve, no matter who is elected, the situation will be very tricky. Timiraos warns that any policy that rekindles inflation could lead the Fed to slow down or even halt its rate-cutting plans.

Timiraos believes that tariffs are akin to tax hikes for the Fed, weakening demand. During Trump's previous term, tariff hikes disrupted the stock market and threatened corporate investment. When the negative impact of tariffs on economic growth outweighed the impact of inflation, the Fed eventually lowered interest rates.

But this time may be different. If tariffs trigger a resurgence in inflation, the Fed will find it hard to stand idly by. Historically, the Fed misjudged the temporary nature of price increases in 2021, missing the opportunity to combat inflation.

Timiraos warns that once price pressures spread, the Fed will significantly raise rates to ensure that businesses and workers do not expect high prices to become the new norm. If a second round of inflation follows shortly after the first, the adjustment will be even more challenging.

All roads lead to inflation? Long gold, short U.S. bonds

Paul Tudor Jones believes that if his predictions about U.S. inflation come true, the U.S. bond market will inevitably face shocks, and gold and Bitcoin could emerge as big winners:

All roads lead to inflation. I am bullish on gold, bullish on Bitcoin, and I think commodities are severely undervalued, so I am also bullish on commodities. I think many young people are seeking inflation hedges through the Nasdaq, and it's performing well.

Jones warns that the next president must address the issue of massive deficits, or else face protests from the bond market. "Bond vigilantes" made a big fuss about this last year, refusing to buy U.S. bonds, causing the 10-year Treasury yield to hit 5% in October last year:

If the next president does not adjust policies to address the rising U.S. debt-to-GDP ratio, the solution to break free from this situation is inflation