Monday Digest
Posted 2 December 2024
Equities and bonds go separate ways
Markets tend to be quiet on the USA’s thanksgiving but, beforehand, trading was a little frenetic last week. French politics hurt its stocks, while Trump tariffs hurt emerging markets. Japanese stocks were volatile – and moved reversely proportional to the yen. US bond yields fell thanks to Trump’s treasury secretary pick, Scott Bessent, whose “3-3-3” plan (covered below) is seen as a bullish for stocks and bonds.
Lower yields were accompanied by lower credit risk indicators for US treasuries – though TIP yields also dropped, perhaps suggesting investors are less convinced about growth plans. If inflation stays low, Fed rates should be accommodative, helping US corporates to borrow more and the government borrow less.
That rosy picture could help Europe. Since 2022, UK and European energy has consistently cost around four times more than US energy and, if that ratio remains, Trump’s plan to lower US energy prices might mean a four times larger price cut for Europe. That will be good for European growth even if the US puts up tariffs.
The main thing holding back positivity is politics. French Prime Minister Barnier just rescinded his electricity tax under pressure from Le Pen’s RN (complicated by Le Pen facing EU fund embezzlement charges), which could derail attempts to bring down France’s unsustainable budget deficit. French yields remained relatively higher than other Eurozone governments.
The fundamental problem – in the UK, Europe and US – is how to tighten budgets without hurting jobs. It’s a tricky problem made harder by governmental instability. Europe’s mainstream parties can’t form cohesive alliances, paving the way for populist parties to gain more influence next year – possibly in Germany and more likely in France. Investors struggle to see upside for Europe, although there are seeds of (economic) positivity.
We note that some bullish US equity sentiment indicators have risen to unprecedented levels recently. While these can be concerning in terms of overconfidence, they aren’t great timing indicators. We remain cautiously optimistic, but we could see volatility if there’s bad news.
Terrifying Tariffs
Donald Trump promised to put 25% tariffs on goods from Canada and Mexico on his first day in office – largely because of narcotics coming across the border. Tariffs would violate the USMCA trade deal Trump himself signed in 2020, and Mexican President Sheinbaum warned she would respond in kind, damaging jobs and inflation for both countries – though Canadian Prime Minister Trudeau was more conciliatory. Trump also threatened additional 10% tariffs on China, again citing fentanyl imports, but it’s unclear what that 10% is additional to.
Mexico and Canada are more important to US exports than China, with the North American neighbours having bought $560bn of US goods and services last year. Trump’s idea is to replace foreign trade with domestic, but many goods and services aren’t easily replaceable. Many companies might not survive the sudden tariff imposition – even those in the US who are supposed to be the ‘winners’ from Trump’s policies.
And there may be unintended consequences – like a weaker Mexican economy incentivising more border crosses into the US. One consequence could be the rest of the world rethinking the largely unfettered access that big US tech companies have to most national markets. Many of them get the majority of their revenues and profit from overseas, so a fight back on that front could end up removing a source of US economic outperformance over the last 15 years.
Ultimately, Trump’s threat probably won’t be come reality. His statements read more like “The Art of The Deal” than a manifesto. Trump’s pick for Treasury Secretary said as much before the election. The danger is that the tariff lever gets pulled too hard too often but, for now, we shouldn’t get too worried. We remember the principle that worked well in Trump’s first term: take him seriously but not literally.
New US Treasury Secretary’s target of threes
Trump’s Treasury Secretary pick, Scott Bessent, has a “3-3-3” plan; cut the budget deficit to 3% of GDP, boost growth to 3% and increase energy production by the equivalent of 3mn oil barrels per day. He was supposedly inspired by Shinzo Abe’s “three arrows” (fiscal stimulus, monetary stimulus, structural reform) but his fiscal plans are the opposite and he isn’t threatening Fed independence.
Bessent is targeting an increase US energy production (he talks about 3mbpd oil “equivalents” although nuclear energy, for example, will take longer than Trump’s term to set up). Lower energy prices reduce incentives for more production so really, the energy “3” is a price-lowering mechanism rather than a hard production target.
A medium-term growth target is realistic in historical terms (US growth has been running at about 2.7% for the last year). He promises growth through smaller government and deregulation – but that’s not how recent US growth has come about. Deregulation has worked in the past – notably in the Reagan years – but that was partly because Reagan could expand the deficit.
Deficit reduction is Bessent’s last “3”; he wants to get it below 3% of GDP by 2028. That didn’t happen under Reagan, and later administrations were only able to do it thanks to lower interest costs and a debt-to-GDP ratio of 40%. That ratio is now over 100%, thanks to the global financial crisis, pandemic, and significant fiscal expansion under both Trump and Biden. Trump’s cabinet wants to cut government expenditure but seems to assume this will have no growth impact or come back through tax cuts – which would mean no deficit improvement.
Realistically, then, the 3-3-3 can’t be achieved all at once. Markets like Bessent, but we should again treat the goals seriously, just not literally.