By Wilfrid Galand, Director Strategist
Trump wants to push US growth as much as possible and limit its trade with the outside world. The Fed cannot remain without reacting. And the markets will arbitrate between these two forces.
This Monday, January 20, 2025, Donald Trump becomes the 47th president of the United States of America. Even if his majority in the House of Representatives is very narrow – 2 votes, taking into account those absent for various reasons – he has all the levers, including in the Supreme Court and in the judicial system where many judges owe their appointment to him. , to implement its economic program.
Les « Maganomics » developed during his campaign, aim to accelerate the pace of economic growth as much as possible by lowering taxes and loosening federal regulatory constraints, while closing the country via import taxes and limiting migratory flows.
From the Fed’s point of view, the full implementation of these measures would mean a risk of stopping the process, already slow, of disinflation, and therefore to its rate cuts. Even before the inauguration, the markets were already banking on only one drop this year.
Bond investors have understood this well. Driven both by expectations of strong economic dynamism and possible strengthening of inflationary pressures, 10-year rates have risen sharply since the end of September, with an increase of almost 100 bps in four months, lifting the yield on T -2035 bonds towards 4.8% mid-January.
Therefore, the main question facing the markets for these first months of the year is the following: in the world of Maganomics, between the rise in rates, which tends to compress valuation multiples, and the rise in profits thanks to business agility and economic growth, who will win?
This situation – simultaneous rise in rates and profits – is in stark contrast to that which prevailed in the 1970s, when these two elements moved in opposite directions, and with that, more recent, of 2022. These two periods were characterized by a inflationary and low growth environment. Conversely, the current period sees strong and resilient growth, in a context of disinflation made fragile by the “supply shock” effect of Maganomics. All this makes market arbitrage more uncertain.
So fareven if the upward movement has diminished considerably since Trump’s surge in the polls in October, then his election in November, investors favored profit growth, expected at +14.6% this year for the S&P500. This is despite a Fed Funds target rate at the end of the year rising from 2.75% last September to 4% since the end of December.
For this trend to continue, two conditions must be met.
1- The first is that American companies keep profit promises contained in valuations that have become very demanding, particularly in the sector of large growth companies, whose capitalization, on average, exceeds 30 times expected profits.
-The start of the results season is, in this sense, promisingsince American banks, which traditionally open this period, have exceeded expectations. But the key will be publications from tech giantswhich are expected at the end of January.
In addition, in order to consolidate expectations of future profits, the next leading economic indicators will be watched closely. However, the first regional indices for January give contradictory signals: service activity in Pennsylvania is better than expected while the manufacturing sector in New York State is stalling.
2- The second is that the rise in rates remains contained below 5% for the 10-year reference. This is all the more important as American companies took advantage of the CoVid period and its very low rates to refinance massively. However, in particular for medium quality raisings (BB and below), the standard maturity of securities is five years, which implies that the refinancing deadline is within the next twelve to ten months.
This also means that the transmission of monetary policy to the economic sphere has been significantly delayed by the exceptional financial conditions. recorded during the pandemic. This is seen in the average refinancing rate of companies, still close to 6%, but this delay effect is coming to an end and the time of reckoning is coming.
For these two aspects – growth and rates – the balances found by the new Republican administration will be essential. It is especially the inflationary aspect that must be monitored : the potential shock on the labor market in the event of a very powerful blockage, or even a reversal of migratory flows, would be similar to the CoVid shock which had caused strong surges in prices.
Such an effect could also take place in the event of commercial escalation with multiple geographies. But, depending on the actual level of customs duties, it could also have a recessive effect, acting like a massive tax increase on the country’s economy.
Faced with this uncertain economic context, the Fed will have to adapt. The statements, Thursday, January 16, of Christopher Waller, permanent voting member of the monetary policy council of the Washington institution, specifying that the possibility of three, even four rate cuts this year, could not be ruled out, caused confusion and shows that flexibility will remain at the center of monetary policy.
If our central scenario materializes, namely a stabilization of rates in a persistent but controlled inflationary context below 3%, accompanying resilient growth despite occasional outbreaks of fever on customs duties, the Fed is expected to keep rates largely unchanged this half-year. In this case, it would benefit from being able to take its time with possibly only one drop during this period.
This scenario allows us to preserve our constructive view of the market for the coming months. The major growth stocks are accompanied in their leadership by industrial stocks with strong domestic exposure, as well as companies in health and well-being, which still benefit from reasonable valuations.
And Europe in all this? The economic and political context of the Old Continent does not encourage optimism, that’s for sure. But many risks related to European selfhood and Maganomics have already been priced into European stock prices. So a little bit of contrarian boldness would not be out of place in our opinion at the start of the year… provided of course that we carefully monitor Trump’s tweets!
