The "Trump 2.0" inaugural year, the key divergence between Goldman Sachs and the market: the Federal Reserve!

In the "Trump 2.0" era, how will the Federal Reserve cut interest rates next year? Goldman Sachs and the market have differing views.

On December 1st, a report released by Goldman Sachs showed that analyst Jan Hatzius and his team surveyed over 500 market participants to compare Goldman Sachs' expectations with those of investors (the market) to better understand the policy expectations reflected in market pricing.

According to the report, Goldman Sachs and the market agree on the impact of Trump’s policies on U.S. immigration and fiscal policy, but there is a divergence regarding the Federal Reserve's interest rate cut path for next year.

Goldman Sachs expects the Federal Reserve to cut interest rates consecutively in the first quarter of 2025, then gradually slow the pace, with the last two cuts occurring in June and September, while respondents' expectations are more hawkish.

Goldman Sachs does not agree with the market's more hawkish expectations. On one hand, Goldman Sachs believes that Trump’s policies are unlikely to create significant inflation that would prevent interest rate cuts; on the other hand, Goldman Sachs believes the market underestimates the significant shock risks that substantial policy changes may pose to financial markets, which could trigger a response similar to the "insurance rate cuts" of 2019.

Divergence: Goldman Sachs believes the market's expectations for Federal Reserve interest rate cuts are too hawkish

Goldman Sachs and respondents have similar views on the fiscal policies that the new Trump administration may adopt, but they differ on the monetary policy outlook resulting from policy changes.

Goldman Sachs expects the Federal Open Market Committee (FOMC) to cut interest rates consecutively in the first quarter of 2025, then gradually slow the pace, with the last two cuts occurring in June and September.

Respondents' expectations are more hawkish, which Goldman Sachs does not agree with for two reasons:

First, Goldman Sachs believes that the policies of the new Trump administration are unlikely to create significant inflation that would prevent interest rate cuts.

Goldman Sachs argues that while a reduction in immigration may exert upward pressure on wages and prices in industries that employ a large number of immigrants, the overall impact on wages and prices will be moderate, as immigration increases both demand and supply.

Additionally, Goldman Sachs expects that the new administration's fiscal stimulus will be moderate and have almost no impact on inflation. Furthermore, under baseline conditions, tariffs will only have a moderate and one-time impact.

Second, Goldman Sachs believes the market underestimates the significant shock risks that substantial policy changes may pose to financial markets, which could trigger a response similar to the "insurance rate cuts" of 2019.

For example, a 10% general tariff could have a dual impact on monetary policy: temporary inflation increases but economic growth slows. During the last round of trade tensions, the Federal Reserve ultimately prioritized growth risks and lowered the federal funds rate by 75 basis points.

Consensus: Slight decrease in net immigration, continuation of tax cuts, and increase in tax relief

Goldman Sachs expects that the new Trump administration will tighten immigration policies—before the pandemic, the average net immigration to the U.S. was about 1 million per year, and Goldman Sachs expects that by 2025, this number will drop to 750,000 per year, slightly lower than pre-pandemic levels, due to certain legal and logistical constraints on administrative measures According to Goldman Sachs' survey, about half of the respondents expect net immigration to remain at a level of 500,000 to 1 million people per year, which is consistent with Goldman Sachs' forecast. Notably, although recent news reports about potential large-scale deportations of immigrants have been rampant, only 6% of respondents expect net immigration to turn negative.

In addition, Goldman Sachs expects that the tax reduction policy from 2017 will be fully extended when it expires at the end of 2025, including the restoration of some expired corporate investment incentives. Goldman Sachs also anticipates that federal spending under the new Trump administration will increase, along with personal tax cuts amounting to about 0.2% of GDP.

Respondents also expect the tax reduction policy to continue, with about two-thirds of respondents anticipating a full extension of the tax cuts, while one-third expect a partial extension.

Regarding personal tax cuts, about two-thirds of respondents expect an increase, but most investors anticipate that these cuts will be below $100 billion, or less than 0.3% of GDP annually.

There is significant variation among respondents regarding expectations for spending cuts by the government efficiency department, with 42% of investors expecting the cuts to be negligible or very limited, 19% expecting cuts between $25 billion and $100 billion, and 32% expecting cuts to exceed $100 billion, equivalent to 0.3% of GDP annually