New Presidential Administration Sparks Economic Policy Uncertainty

Transition Causes Economic Policy Shifts

A new presidential administration is set to begin later this month, leading to speculation about possible shifts in various policies, including tax, trade, and regulation. This situation has led to what analysts describe as “policy uncertainty.”

Policy uncertainty is a familiar phenomenon during transitions between administrations, not just in the U.S. Economists have developed indexes to quantify this uncertainty globally, often using news article counts to gauge the perception of uncertainty surrounding different policies.

Understanding Economic and Trade Policy Uncertainty

There are two relevant types of indexes to consider: broad economic policy uncertainty and more focused trade policy uncertainty.

Reviewing data from 1990, economic policy uncertainty (illustrated in blue in the chart below) has exhibited greater volatility. Typically, it spikes during recessions (grey shaded areas) and drops during periods of economic growth (white areas). Currently, it hovers around its historical average (zero line), similar to trends seen during President Trump’s first term before the pandemic recession.

In contrast, trade policy uncertainty (depicted in purple) remained relatively stable from 1990 until President Trump took office, when tariffs were reintroduced, leading to increased fluctuations. In the wake of the recent election, trade policy uncertainty has surged back to levels not seen since President Trump’s first administration.

Market Reactions to Policy Uncertainty

Old adages like “markets hate uncertainty” suggest trade policy uncertainty might negatively affect the stock market. However, an analysis comparing the VIX, a volatility index (shown in orange in the chart below), with trade policy uncertainty reveals little correlation between the two.

Notably, during periods of high trade policy uncertainty in 2018, 2019, and again now, the VIX has generally remained below its average since 1990 (indicated by negative readings in the chart). Additionally, the S&P 500 and Nasdaq-100 have both witnessed ten new record highs since the election.

On the other hand, the data shows that economic policy uncertainty does have a significant effect on markets. When there are spikes in economic policy uncertainty, the VIX tends to surge as well. This correlation suggests that heightened uncertainty during recessions—particularly severe ones—can drive market declines due to speculation over necessary economic policy responses.

Trade Policy’s Limited Effect on Markets

The primary distinction between economic policy and trade policy is their scope. Economic policies encompass a broader range of issues, while trade policies focus specifically on international trade, making them less impactful overall on the economy’s health.

Historically, when uncertainty remains confined to trade policy, the resulting effects on markets also tend to be minimal.

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