In the first few trading sessions in the aftermath of the election result we saw US equities responding very positively to a decisive election result
Investors have initially taken the ‘glass half full’ view of life under Trump 2.0 with the rhetoric on trade and tariffs being seen as a policy and negotiation tool rather than hard numbers to be applied on imports and factored into forecasts for inflation and corporate earnings.
As time passes, we anticipate more of a focus on the implications of policies set to boost growth and potentially drive inflation higher. Rose tinted memories of 2016-2020 may well be clouding investors assessment of the intentions of the new administration – in 2016 Trump was clearly unprepared for victory while this time round the speed of departmental appointments makes it clear that Trump is likely to hit the ground running with policies already formed meaning implementation is likely to be swift. It is also clear from the nominations made over the past week that Trump is choosing a top team that will support his plans to shake up government, choosing loyal supporters over more conventional and experienced individuals.
During the campaign, Trump mooted tariffs of 60% on China and 10-20% elsewhere during the campaign. Time will tell what levels we ultimately end up with, but it is clear tariffs will be higher over the coming years even if those headline levels are ultimately diluted. The impact on global trade and inflation could be significant, creating challenges for central banks. Indeed, ‘higher for longer’ is a narrative around interest rates that could be the backdrop to 2025 as inflation settles above central bank targets. A further unknown is how far Trump will go on his promises of “mass deportations”, a policy move that would likely push domestic wages, and inflation, significantly higher. Even before the US election result, markets had already been reassessing the depth of interest rate cuts in 2025, with the Fed Funds Rate in December 2025 expected to be 3.82%, which implies ‘only’ three 25 basis point rate cuts before the end of next year. In the past six weeks, the expected interest rate for the end of 2025 has risen by almost 100 basis points. It comes as no surprise to see the strengthening of the US Dollar over recent months. Ultimately the market will need to decide if a backdrop of deficit funded economic stimulus and tax cuts combined with tariffs is inflationary – it certainly appears to be – and how this will influence Fed policy at least while Jay Powell is in control of the Federal Reserve.
The US reported inflation data on Wednesday with CPI for October at 2.6% YoY, in line with expectations and up from 2.4% in September. Core CPI was unchanged at 3.3% with monthly core prices climbing 0.3% for the third month in a row. Treasury yields fell back with some relief it seems that inflation did not surprise to the upside. Fed Chair Jay Powell said last week he expected inflation to “come down on a bumpy path over the next couple of years” before settling near the bank’s 2 per cent target rate. Powell also noted “in the near term, the election will have no effects on our policy decisions”. For now, the data is in a sweet spot as far as the Fed is concerned, with Jay Powell saying yesterday the US economy’s recent performance is “remarkably good” and is “not sending any signals that we need to be in a hurry to lower rates”. The Fed will, for now, base their policy decisions on the economic data even though the spectre of potentially inflationary policies from the new Trump administration is on the horizon.
Elsewhere in the economic data, the UK reported employment numbers for September, with the unemployment rate seemingly rising sharply to 4.3% from 4.0% in August. The UK unemployment data has become unreliable, with the same size of the Labour Force Survey having collapsed post-pandemic. As a result, the unemployment rate is showing notable volatility but the data is consistent with a very gradual increase in the unemployment rate. The closely watched wage data saw growth in earnings ex-bonuses up 4.8% in the three months to the end of September, showing signs of stabilisation albeit at levels that suggest the Bank of England will continue with their cautious approach to rate cuts as expressed by Governor Andrew Bailey last week. UK GDP data for Q3, released this morning showed growth of just 0.1%, lower than expected. Data for September showed the economy actually contracted slightly during the month. The climb to the new Labour government’s aspiration of 2.5% annual GDP growth will be a long and difficult one.
We already have one major election set for early 2025 following the collapse of the fragile coalition in Germany. Last week saw German Chancellor Olaf Scholz call for a confidence vote in early January while sacking his Finance Minister Christian Lindner of the FDP party. Following discussions this week, the confidence vote has been brought forward to mid-December, with the election to follow on 23 February next year. The current coalition has been at odds for some time, with Chancellor Scholz demanding more fiscal ‘wiggle room’ while Finance Minister Lindner has consistently refused to suspend the constitutional debt brake, which limits annual structural deficits to 0.35% of GDP. With other countries such as France, the UK and US running significant deficits, some German politicians are feeling very constrained by the debt brake, though the current dispute is as much about funding for Ukraine as domestic fiscal stimulus. Opinion polls put Friedrich Merz’s CDU/CSU alliance ahead with over 30% of the vote while Chancellor Scholz’s SPD party is in third place, polling around 16%, behind the far-right AfD party. The FDP is polling only 4%, below the 5% threshold to enter Parliament. The CDU/CSU alliance of Friedrich Merz, and previously Angela Merkel, has long been tied to the debt brake. But there are signs of a shift, at both a regional and national level in giving more flexibility on fiscal spending, something that could take on more urgency should tariffs from the US begin to impact on a Germany economy already struggling to grow.
In the latest round of incremental policy measures to support the economy, China unveiled a $1.2 trillion programme to restructure local government debt. The government once again stopped short of fiscal stimulus or measures to drive consumer demand. Markets were underwhelmed but there was talk of the government potentially holding back to the see the size and scope of US tariffs under new President Trump before further measures. Finance Minister Lan Fo’an promised “more forceful fiscal policy next year”. It’s already clear that 2025 will, for many countries around the world, see policy guided by the actions of the new Trump administration.
Source: Bloomberg as at 15 November 2024
