Trump’s power appears to be waning—what’s next?

Tuesday's election results prompted a rare admission from US President Trump that some things weren't going well for him. In a discussion with his own senators about the reasons for the Democrats' landslide victory in New York City, New Jersey, Virginia, and California on Tuesday, Trump stated, "The government shutdown was a major factor, which was bad for the Republicans." The Supreme Court also seemed to be adding to the turmoil. In a closely watched hearing on Tuesday, conservative judges questioned the government's rationale for imposing tariffs. Supreme Court rulings are notoriously unpredictable, but the series of political setbacks over the past few days suggests that the Trump administration is experiencing a turning point. The president, who once single-handedly pushed through policies that frequently caused significant fluctuations in the stock market, bond market, and dollar, now suddenly finds himself facing more constraints. Investors may feel immediately reassured, as the current situation has driven the stock market to record highs while bond yields remain relatively low and continue to decline. However, this shift in the US political landscape also brings some long-term concerns. With the midterm elections approaching, Trump's personal power may be weakened; meanwhile, the opposition party is also adopting his strategies. A new generation of Democrats is equally willing to fight for and wield power in unprecedented ways. This could disrupt the current situation—where investors have previously focused on the prospects of artificial intelligence and expectations of Federal Reserve rate cuts, ignoring the political turmoil. The current policy environment is relatively stable, although the Supreme Court's questioning of tariff policy remains an uncertainty. At the hearings, Trump-appointed justices questioned whether tariffs inherently fall under the tax and spending policies that the Constitution grants to Congress, rather than the president. US Treasury Secretary Bessant recently stated that the tens of billions of dollars in revenue generated by tariffs to date are crucial to the government's described fiscal situation. The fiscal deficit as a percentage of GDP will fall to 5.9% from 6.4% last year. “If we are cutting spending, then inflation should go down. If inflation goes down, the Fed should cut interest rates,” Bessant said in a CNN interview on November 2. Some in the market worry that a Supreme Court ruling invalidating the tariffs would cut off a source of revenue, worsening the deficit and threatening this trend. But such concerns may be exaggerated. “While this Supreme Court case is significant, it is unlikely to change U.S. tariff strategy or the willingness to continue using this revenue in the future,” said Greg Peters, co-chief investment officer of fixed income at Pacific Investment Management Company (PGIM). The Trump administration may act quickly to impose alternative tariffs under other legal authorizations to ensure continued funding to the Treasury. Nevertheless, the administration will remain on the defensive regarding its signature policies. It might be able to find enough revenue to appease the bond markets, but countries forced to the negotiating table may be unwilling to make or fulfill concessions, given the questionable nature of the president's power. This could slow the flow of trillions of dollars in pledged investment into the U.S. economy. Trump is also hampered in Congress. The Senate recently passed a resolution to terminate the emergency declaration he uses to defend several tariffs. While the House opposed it, and the measure won't actually reach Trump, it's a powerful political symbol. Republican senators also rejected Trump's request to abolish the filibuster, a process that requires most bills to pass with 60 votes. "The Democrats' strong performance after Tuesday's election may have made some Republicans less willing to cooperate with Trump before the midterm elections, out of self-preservation," wrote Lew Lukens and George Pollack of the analytics firm Signum Global Advisors in a briefing to clients. Trump is adept at achieving his goals in unexpected new ways, and it would be unwise to underestimate him based solely on an opponent's victory on a single day. But from a broader perspective, this election shows that Trump is not always the loudest voice in politics. "Trump is no longer the only 'Trump-like' figure," said Ed Price, a nonresident senior fellow at NYU's Center for Global Affairs. Among the new generation of "Trump-like" figures is Zohran Mamdani—the charismatic young democratic socialist elected as the next mayor of New York City. He won on a series of costly policy promises that will be difficult to fulfill. For example, he wanted New York City to issue $70 billion in debt to build new affordable housing, but this plan would exceed the state's constitutional debt ceiling—his solution being to remove that ceiling. Similarly, in California, Governor Gavin Newsom successfully pushed through a proposal to redraw the state's districts in favor of congressional Democrats. He touted this as "fighting fire with fire"—using Trump's own tactics to defeat Trump. Trump is pushing states like Texas to redraw districts to give Republicans more seats and an advantage in the midterm elections (which are typically unfavorable to the incumbent party). Former Vice President Harris lost her presidential campaign; while her campaign promises verbally mentioned reducing the deficit, they only made minor changes (in fact, her spending plans only exacerbated the deficit problem). The next Democratic presidential candidate is unlikely to impose such self-imposed limitations. For example, Harris promised a complex tax break to help first-time homebuyers. But after Mamdani made no secret of his call for a rent freeze, such small-scale measures are no longer a selling point. The lesson of the Democrats' victory over Trump by mimicking him is unsettling, especially with inflation hovering around 3%. Given the risk of a rebound in inflation, the Powell-led Federal Reserve is already reconsidering its plans for rate cuts in December and beyond. But Powell's term as chairman is ending, and Trump has pledged to replace him with a candidate committed to further rate cuts. The problem with this policy isn't that it will harm the market—at least not initially. Looser monetary policy could boost stock and cryptocurrency prices. The problem is that once the tradition of the Fed's independence is broken, no politician will be willing to "take the party bowl" (i.e., tighten monetary policy). This is true for both the more "Trump-ized" Democratic Party and Trump himself. Trump's "winner-takes-all" approach to governance has increased the risks in American politics. He has used his power to support the markets through various means, such as deregulation and tax cuts. But the problem with changing the game is that the other side will also stop abiding by those rules. Trump has sparked a power struggle that prioritizes "winning" over sound policymaking. How long this situation can sustain a strong economy and healthy markets is anyone's guess.