Trump trade still on?

Posted 24 January 2025

Capital markets were a sea of green in Donald Trump’s first week back in office. Investors’ serenity stands in contrast to the rhetoric and early flurry of policy from the US president. We have said before that markets may not to appreciate the risks of a second Trump presidency, but US positivity – at least for the near-term – is undeniably justified by the real economy. Hopefully, some of that positivity can spread to the gloomier corners of the global picture, most notably Europe.

Are Americans too positive or are we too negative?
US investors clearly like President Trump and his tax cut, deregulation agenda. This week’s stock market rally showed that, but there is no more visceral a sign of Americans’ faith in the Trump trade than the soaring value of the president’s own personal cryptocurrency – released just days before his inauguration. Albeit, $TRUMP quickly fell back down, as we discuss in a separate article.

We have argued here many times that US investors seem to underappreciate the risks of Trump 2.0, but we should recognise our own potential for bias. According to surveys undertaken by The European Council on Foreign Relations, Britons and Europeans are among the most pessimistic about what Trump’s presidency means for them out of everyone in the world – with only South Koreans feeling more nervous.

It is hard to say whether US investors are too positive or we are too negative – but their acceptance of the Trump trade narrative appears to be particularly one-sided. They think the president means all the market-friendly things he says, but that all the disruptive/inflationary things (e.g. extreme tariffs, deportation of a percentage of the workforce and invading Panama) are purely “the art of the deal”.

Yet, early signals suggest the dealmaking interpretation might be right. Trump’s immediate approach to the Russia-Ukraine war has been less friendly to Putin than expected. Regarding China, Trump called them a trade abuser on Wednesday but said he was considering only 10% tariffs (rather than the 60% promised before the election). Then, in a Fox News interview on Thursday, Trump described China as a “big power”, saying he’d rather not have to use tariffs.

Still, even with a view that Trump is benignly transactional, we should appreciate the potential for political volatility to impact or frustrate policy. The Trump administration has already lost its first official: co-head of the new Department of Government Efficiency Vivek Ramaswamy left his role the moment Trump reached the White House, reportedly after a fallout with Elon Musk – now the department’s sole head. Meanwhile, Musk also criticised an AI infrastructure investment announced by Trump, and there would be few surprises if tensions start to build between Trump and his multibillionaire adviser.

Positivity isn’t just about Trump.
It would be wrong to label all of the recent US optimism as a Trump trade. The US economy is proving its strength, particularly in terms of consumption – the pillar of growth in recent years. We noted before that the ‘soft’ sentiment data was not being backed up by the ‘hard’ economic activity data, but the hard data is now clearly catching up. It is feeding through into corporate earnings too, as company reports from Q4 2024 have tended to show in the first two weeks of the 2024 fourth quarter earnings season. We might worry about stretched US equity valuations, but American exceptionalism is – for now – entirely justified by profit growth.

Markets are also supported by recently dovish signals from the Federal Reserve (preferring lower interest rates). Investors’ belief in ‘America First’ had previously led to higher government bond yields and a much stronger dollar – but Fed dovishness meant the opposite this week. Lower yields and a weaker dollar are positive for global markets, effectively meaning looser financial conditions. The bond market relief is not just in the US either; investors see current yields as very attractive, particularly in longer-dated bonds.

The most in-demand bonds this week are UK gilts. Following the scare of a few weeks ago, 10-year gilt yields have now moved below US treasury yields. Investors see longer-dated gilts as extremely attractive – exemplified by a record oversubscription for issuance of a bond expiring in 2040. 30% of the orders came from overseas, as international investors showed significant faith in UK debt. Thankfully, the rumours of gilts’ demise were greatly exaggerated.

Are we passed peak pessimism for Europe?
The flipside of investors putting America first is that many have also put Europe last. At the World Economic Forum in Davos, one US bank executive described “peak pessimism” about the European economy. Even ECB president Christine Lagarde spoke of the continent’s “existential crisis” in the face of economic contraction and painfully high energy prices. However, we note that recent economic data from Europe has been more mixed than bad – and certainly not negative enough to justify sustained investor pessimism.

In this context it is notable, that the Europe ex UK large and mid-cap Bloomberg stock index total return has exceeded its US large and mid-cap counterpart since the start of the year. Given the negative narrative, we find it remarkable that German stock total returns are +12% since the end of October, while US stocks are +12.3%.

Business sentiment, represented by the Purchasing Manager Indices that were released on Friday, support the perception of Europe’s turn. The chart below shows the composite measures for the Eurozone, UK and US. While Europe lags behind, it has moved above the neutral 50 level and has risen faster since the November bottom.

Meanwhile, the US PMI remained above 50 but was substantially below economist estimates. This was likely a combination of things: the sharp increase in mortgage rates on the back of rising bond yields over December, which have since reversed downwards, and the sense of a pause, as businesses waited to see what Trump would actually do. As such, the preliminary data is quite likely to be revised higher and economists will expect February to return to buoyancy.

EU leaders know that their already-weak economy is vulnerable to Trump tariffs, but they clearly want to take a constructive, diplomatic approach and will be angling for a deal. There was a recognition from European policymakers in Davos that European nations do indeed need to spend more on their militaries and coordinate their defensive capabilities – one of Trump’s main gripes. If that comes true, it will inevitably mean fiscal expansion on the continent. Even though military spending typically is not considered productive long-term investment, we should not underestimate the stimulatory effects this could have over the shorter term.

The thing about “peak pessimism” is that it always gets better from there. Global investors, particularly in the US, have been persistently negative on Europe. However, since November we have argued there is a plausible scenario for an economic recovery which might be further boosted by a mitigation of political risks, both in terms of Trump tariffs and Ukraine. European sentiment may be rising from the depths.