Weekly Market Commentary (November 19, 2024)

Muzinich’s weekly take on key developments in financial markets and economies examines what Trump 2.0 could mean for inflation, interest rates and U.S. Treasuries.

Economic data and earnings took a back seat last week as investors continued to evaluate and adjust their expectations for the incoming Trump administration’s economic policies. Three of the main areas of focus are taxes, tariffs and immigration, with debate over how Trump’s policies could conflict with the top concern of many American voters, the rising cost of the life.

Tariffs are generally considered inflationary. Importing companies, which bear the cost of tariffs, often attempt to pass on at least part of these costs to consumers, while competitors who are not subject to tariffs can conveniently raise their prices accordingly.

Tariffs can also have a negative impact on employment because exporting countries often devalue their currencies in response, making U.S. exports less competitive. Worse still, domestic manufacturing activities can become unviable when the higher cost of raw material imports makes production prohibitive. This is the conclusion reached by the Federal Reserve following the steel and aluminum tariffs imposed by the Trump administration in 2018[1].

Saving money?

A similar conclusion is drawn regarding immigration policy. Evictions can lead to labor shortages in an economy already operating near full employment[2]which ends up driving up prices. For example, the construction sector, which is already experiencing a labor shortage, uses approximately 1.5 million undocumented workers, or nearly 13% of its workforce.[3].

Although details of the administration’s tax plan remain scattered, the most likely proposal is to extend the 2017 Tax Cuts and Jobs Act passed during Trump’s first term, which is 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 takes into account economic feedback effects[5].

Bad news for Treasuries

Overall, the administration’s initiatives appear unfavorable for U.S. interest rates and government bonds. Investors have lowered their expectations, with the US swaps market pricing in a 58% chance of a 25 basis point (bps) rate cut in December and only expecting full easing by 71 bps by the end of 2025[6].

Unsurprisingly, the US government bond market significantly underperformed last week, with yields rising more than 10 basis points across the curve. At the same time, the greenback strengthened, with the US Dollar Index, which measures the value of the dollar against other currencies, appreciating to its highest level in 12 months[7].

Domestic risk assets showed resilience, with high-yield credit outperforming investment grade and the S&P 500 crossing the psychological 6,000 mark, a milestone that may not be entirely justified given the season mixed third quarter profits. Of the 455 S&P 500 companies that have reported results so far, 75% have beaten estimates, up from 80.4% in the second quarter[8].

In contrast, Asian stock markets struggled, with the Bloomberg Asia Emerging Markets Large & Mid Cap Index down more than 4% for the week. This suggests, at least in part, that investors are ignoring the signs of growth that are starting to emerge in China thanks to favorable government policy.

Chinese retail sales in October rose 4.8% on an annualized basis, up from 3.2% in September, well above the consensus estimate of 3.8% and marking the fastest sales growth in eight months[9]. And, in a symbolic gesture, 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 has surpassed $40 billion, with yields falling 26 basis points from their U.S. Treasury equivalents in a frenzied first day of trading[10] (see chart of the week).

Trump and Germany concerns weigh on Eurozone sentiment

The first opportunity to assess Eurozone sentiment towards the incoming administration came on November 12, with the latest Economic Sentiment Indicator for Germany from the ZEW Institute, which reflects views financial professionals rather than real economic activity.

The indicator fell to 7.4, from 13.1 the previous month and below the ten-year average of around 13[11]. Furthermore, the ZEW Institute’s Economic Situation Indicator fell to -91.4, approaching the pessimistic levels reached during the COVID-19 pandemic in 2020. While the ZEW said the result of The US presidential election was “probably the main reason” for the drop in sentiment, with the recent collapse of Germany’s coalition government being another contributing factor.

Chart of the Week: Clash of the Superpowers – Chinese USD Debt vs. US Treasury Bonds on November 14

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