The new administration in the United States has anticipated a more aggressive trade policy, along with tax cuts and immigration policy changes. All of this will have effects on the rest of the world. The question is how deeply and at what pace these measures will be implemented. Europe in the crosshairs of a possible trade war. While the economies in Latin America today are basically driven by local factors. 2025 could be a year that marks a major divergence between the United States and the rest of the world in terms of growth and economic policies.

"I'm interested in the future, because it's the place where I plan to spend the rest of my life." The phrase, which belongs to the famous actor and film director Woody Allen, reflects that even in uncertain and volatile times, the effort to anticipate possible scenarios is always worth it.

There is no doubt that 2025 will be a particularly difficult year to forecast. The ongoing geopolitical conflicts, the uncertainty about the economic direction that the new administration will have in the United States (the largest economy in the world), its impact on the rest of the world, and many other factors make any speculation regarding the economic future in the next 12 months subject to frequent review.

The starting point

But let's not lose sight of the initial photo. The starting point for the global economy in 2025 is positive. The world is completing one of the most successful "soft-landing" cycles in contemporary history. There are few historical records of periods of global monetary tightening (rate hikes) that have been so efficient in reducing inflation without significantly deteriorating economic activity.

In mid-2022, inflation soared to levels not seen in four decades. The United States, Europe and Latam saw price increases of around double digits annually. Central banks reacted by raising interest rates. In fact, 2023 set a record: it was the year in which a greater proportion of central banks around the world raised interest rates (8 out of 10) at the same time.

The global rise in interest rates eventually managed to return inflation to acceptable levels. Today it is already heading towards the 2% target in countries such as the United States or the Eurozone. And it was achieved with the world growing around 3% this year, which although it is not a record is not a bad figure either. The United States will grow by more than 2.5% in 2024 and the Eurozone will have a more moderate expansion, which could be around 1%.

Thus, the end of 2024 and the beginning of 2025 finds the world in an advanced process of interest rate cuts, falling inflation, sustained growth and resilient labor markets. The starting point is auspicious. The United States is on a soft landing (sometimes so soft that it seems like it won't even land) given the staggering strength of its economy. Europe, on the other hand, is in a timid cyclical recovery, with two different realities between the countries of the south (with strong growth, such as Spain) and those of the north whose ceiling is given by the structural problems faced by Germany, which represents 30% of the region's GDP, to which the turbulent political situation in France has recently been added. Meanwhile, on the other side of the world, China continues its course of structural slowdown, traveling from an annual growth rate of 5% to 4% in the coming years.

What's next

Undoubtedly, the salient event at the end of 2024 that will mark the economic agenda for 2025 will be Donald Trump's mandate in the United States, a country that accounts for a quarter of the world's GDP. About Trump we know what he says he is going to do. But we don't know what it will actually do. Analyzing the experience of his first administration (2017-2021), both things may differ significantly.

In this context, it is convenient to pass through the sieve of "Realpolitik" some of its main statements. The main policies that he has anticipated that he will apply with an economic impact are:

1. Increase in trade tariffs (in different proportions)
2. Reduction of the tax burden in the United States 
3. Restriction of migration and/or deportations 
4. Foreign policy, particularly on the fronts of military conflict.

The effects of these measures differ significantly depending on several parameters:

1. Whether the impact of these measures is considered to be short-, medium-, or long-term
2. Whether they are assumed to be applied immediately or delayed (voluntarily or involuntarily)
3. Whether they are assumed to be applied literally or not (only partially).

For our purposes, in our base scenario we assume a relatively pragmatic Trump rather than a literal one (he partially applies what he has said). In other words, the increase in tariffs on the rest of the world is moderate, tax cuts in the US, although advancing, are not complete, and mass deportations of immigrants are impossible to carry out operationally, so it only remains in a reduction in the flow of migration to the US. We also consider it appropriate to evaluate only, for the moment, its impact in the first 12 to 18 months of government, given the uncertainty to go well beyond that period.

Under these considerations, the policies proposed by Trump a priori would have the following effects on the U.S. economy: higher short-term growth (if applied moderately) and also higher inflation. In this context, the Fed could be forced to slow down the rate cut cycle and/or end it at a higher terminal rate. This is what the market has called the "Trump Trade" and has as a corollary a stronger dollar against the rest of the world's currencies. The strength of the dollar, strictly speaking, responds to three trends:

1. Macrofundamentals in the US that are more solid than in the rest of the world
2. Geopolitical risk (the dollar is a store of global value)
3. And finally, the aforementioned "Trump effect", given that its policies will force the Fed to maintain somewhat higher rates than expected, generating more incentives to go to the dollar against other currencies.

The Age of Divergence

Strictly speaking, while the policies that Trump pre-announces would mean more growth and some more inflation in the short term for the world's largest economy, in the rest of the world growth could suffer from those same policies. It is not unreasonable to start thinking about a period of divergence in macroeconomic trends. While the United States maintains a considerable growth rate and is forced to tighten its monetary policy at the margin, strengthening the dollar; other countries will see further economic cooling and weaker currencies.

The effect that these changes will have on the conduct of the American economy on the rest of the countries is still uncertain. And it will depend in many cases on the cyclical position of these countries or regions. The impact of the tariff war, tariff hikes and possible retaliation, is always difficult to predict with respect to the reaction of a central bank because it is essentially a supply shock (it retracts trade and GDP, while increasing prices).

However, we can draw some conclusions. In those countries where growth is robust and a depreciation of their currencies has a clear pass-through in economic jargon, the response of central banks could be to tighten monetary policy. The typical example could be Brazil, which is also currently facing its own episode of exchange rate and market volatility, resulting from fiscal imbalances.

By contrast, in countries or regions where growth is tepid or waning and pass-through is low, central banks could even cut rates further to encourage activity and offset the negative impact of, for example, U.S. tariff policies. This could be the case with the European Central Bank. The euro has depreciated significantly in recent weeks against the dollar, in part because the market is anticipating this divergence in monetary policies between the two blocs. Strictly speaking, as said, macroeconomic fundamentals (more solid in the United States compared to Europe) and geopolitical uncertainty also play in the direction of seeing an even stronger dollar going forward.

Europe

For Europe, Trump's arrival undoubtedly brings back to the table what the Letta and Draghi reports already anticipated: a total "reset" of the region's competitiveness is required, with a holistic and 360-degree vision. When Trump announces huge tax cuts and extensions, market deregulation, etc.; it is injecting competitiveness into a US economy that has already shown a far superior performance to that of Europe. Today the difference in GDP per capita is almost 40% in favor of Americans, when three decades ago it was 35%.

The arrival of the new US administration finds Europe with its own internal, economic, coordination problems, etc. In the promised "trade war" that is coming, the EU is susceptible to entering the chair ball. After China, it is the second largest contributor to the U.S. trade deficit. In Trump's "mercantilist" view, that means "we have to talk." The deficit of the US with the Eurozone is about 200 bn euros per year, explained by products such as cars, medicines, etc. 40% of this trade imbalance is generated by Germany (rainy, wet...), and within Germany it is mainly explained by the car industry. All this will be under discussion. Surely Europe will try to avoid entering into an open war and will seek to bring everything to the field of negotiations. Everything indicates that more LNG, weapons, and tariffs on cars will have to be bought from the United States. At least to begin with.

The second issue to take into account with Trump in the case of Europe is military. Given that his stance regarding the war in Ukraine seems to have 2 tracks.

1. Say that it will solve it shortly.
2. Warn that it will not continue to finance the war with US weapons and budget. In any case, all the changes mean that European countries will have to rethink the 2% of GDP defense contributions agreed in NATO, given that half of them do not meet them. It implies greater expenditures, at a time when fiscal rules demand the opposite: moderation.

With all this panorama, Trump's arrival will raise more doubts for the ECB on the growth side than on the inflation side. This, in an area already thirsty for growth, could force the authority led by Christine Lagarde to cut rates even slightly lower than expected.

Latin America

The effect that the new U.S. administration may have on Latin America is heterogeneous. Partly because the countries of the region are mostly in different economic cycles, and partly because of their own idiosyncratic issues. But some general issues can be outlined. The strong dollar is not usually good news for the region. First, because it implies weaker (depreciated) Latin American currencies in economies where the pass-through is usually high. This will force some economies to cut rates less or maintain a more hawkish monetary stance.

Second, because part of the debts of these Latin American economies is in dollars, which implies a greater effort to pay their commitments, at a time when debt-to-GDP ratios are already high and when several of them must begin to do their homework to reduce the growing fiscal deficits.

According to the IMF, a 10% rise in the value of the dollar makes global trade more expensive and reduces growth in emerging countries by 1.9 percentage points and by 0.6 percentage points in developed countries.

The other way Trump can affect Latam is through China and commodities. Periods of strong dollar are associated with relatively depressed commodity prices, similar to the effect that could occur if the U.S. trade war with China significantly slows the latter's growth. In any case, the development of Latin American economies today depends largely on their own internal policies and challenges, with their own dynamics, which largely determine the economic future.

Conclusion

Which Trump will we see leading the world's largest economy? The honest answer is, today no one knows for sure. We will find out (including him) by doing the way. But it is important to be prepared. 2025 is likely to be a volatile year, with markets moving by dint of tweets (X now) from the US president's official account.

2025 will possibly be remembered as the final defeat of inflation that hit the world in previous years. But it could also be the year of the "great divergence" in the policies and economic trajectories of the United States and the rest of the world.