Muzinich Weekly Market Comment: Make America Inflationary Again?
Viewpoint
November 18, 2024
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In our latest roundup of the key developments in financial markets and economies, we consider what Trump 2.0 could mean for inflation, interest rates and US Treasuries.
Economic data and earnings results took a back seat last week, as investors continued to assess and adjust their expectations for the incoming Trump administration's economic policies. Three of the main areas of focus are tax, tariffs and immigration, with debate over how Trump’s policies might clash with many US voters’ primary concern, the rising cost of living.
Tariffs are generally considered inflationary. Importing companies, which bear the cost of tariffs, will often try to pass on at least part of these costs on to consumers, while competitors not subject to the tariffs might opportunistically raise their prices accordingly.
Tariffs can also negatively impact employment, as exporting nations often devalue their currency in response, making US exports less competitive. Worse still, domestic manufacturing operations can become unsustainable when the higher cost of raw material imports makes production prohibitively expensive. This was the conclusion drawn by the Federal Reserve following the steel and aluminium tariffs imposed by the Trump administration in 2018.[1]
Cutting corners?
A similar conclusion is being drawn regarding immigration policy. Deportations can lead to labour shortages in an economy already operating at close to full employment,[2] ultimately driving up prices. For instance, the construction industry, which is already experiencing a worker shortage, relies on an estimated 1.5 million undocumented workers — about 13% of its workforce.[3]
While details of the administration’s tax plan remain sparse, the most likely proposal involves extending the Tax Cuts and Jobs Act of 2017 enacted during Trump’s first term, which are set to expire in 2025.[4]
Economists at the University of Pennsylvania estimate that the tax and spending proposals would increase primary deficits by $5.8 trillion over the next 10 years on a conventional basis, and by $4.1 trillion on a dynamic basis that accounts for economic feedback effects.[5]
Bad news for Treasuries
Taken as a whole, the administration's initiatives appear unfriendly to both US interest rates and government bonds. Investors have scaled back their expectations, with the US swaps market pricing in only a 58% chance of a 25 basis points (bps) rate cut in December and only anticipate a total of 71bps of loosening by the end of 2025.[6]
Unsurprisingly, the US government bond market underperformed notably last week, with yields rising by over 10bps across the curve. Meanwhile, the greenback strengthened, with the US Dollar Index, which measures the value of the dollar relative to other currencies, appreciating to a 12-month high.[7]
Domestic risk assets showed resilience, as high-yield credit outperformed investment grade and the S&P 500 crossed the psychological 6,000 mark, a milestone that may not be fully justified given a mixed Q3 earnings season. Of the 455 S&P 500 companies that have reported so far, 75% beat estimates, down from 80.4% in Q2.[8]
In contrast, Asian equity markets struggled, with the Bloomberg Asia Emerging Markets Large & Mid Cap index down over 4% for the week. This, at least in part, suggests investors are dismissing signs of growth beginning to emerge in China thanks to supportive government policy.
Chinese retail sales in October climbed 4.8% on annualised basis, up from 3.2% in September, significantly exceeding the consensus estimate of 3.8% and marking the fastest sales growth in eight months.[9] And, in a symbolic move, China raised US$2 billion through the sale of three-year and five-year US dollar-denominated government bonds — its first dollar issuance since 2021. Investor demand exceeded US$40 billion, with yields falling 26bps below their US Treasury equivalents in a frantic first day of trading[10] (See Chart of the Week).
Trump, Germany concerns hit Eurozone sentiment
The first opportunity to gauge the eurozone's sentiment toward the incoming administration came on November 12, with the ZEW Institute's latest Indicator of Economic Sentiment for Germany, which reflects the views of finance professionals rather than actual economic activity.
The indicator dropped to 7.4, down from 13.1 the previous month and below the 10-year average of around 13.[11] Additionally, ZEW’s Economic Situation Indicator declined to -91.4, nearing the pessimistic lows seen during the COVID-19 pandemic in 2020. While ZEW said the US presidential election outcome was “likely to be the main reason” for the decline in sentiment, the recent collapse of the German coalition government was another contributory factor.
Chart of the week: Clash of the superpowers – China US$ debt vs US Treasuries on November 14
Source: Bloomberg, as of November 14, 2024. For illustrative purposes only.
Past performance is not a reliable indicator of current or future results.
References
[1] US Federal Reserve, ‘Disentangling the Effects of the 2018-2019 Tariffs on a Globally Connected U.S. Manufacturing Sector,’ December 23, 2019
[2] The Brookings Institution, ‘The full-employment rate of unemployment in the United States,’ September 25, 2024
[3] NBC News, ‘Trump vows to deport millions. Builders say it would drain their crews and drive up home costs, October 19, 2024
[4] IRS, ‘Tax Cuts and Jobs Act: A comparison for businesses,’ November 5, 2024
[5] University of Pennsylvania, ‘The 2024 Trump Campaign Policy Proposals: Budgetary, Economic and Distributional Effects,’ August 26, 2024
[6] Bloomberg, World Interest Rate Probability, as of November 15, 2024
[7] MarketWatch, DXY, as of November 15, 2024
[8] FactSet, ‘Market Is Punishing Negative EPS Surprises More Than Average for Q3,’ November 12, 2024
[9] State Council Information Office, ‘China's retail sales of consumer goods up 4.8% in October,’ November 15, 2024
[10] Bloomberg, ‘Yields on new China dollar bonds fall below Treasuries in debut,’ November 14, 2024
[11] ZEW, ‘Falling Economic Expectations After Trump Victory
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