Clarity in the US, renewed tensions in the eurozone

The broad outlines of economic policy across the Atlantic have rapidly become clearer following Donald Trump's resounding electoral victory. In the eurozone, political turmoil in France and, to a lesser extent, in Germany, has markets on edge against a backdrop of tepid growth.

Donald Trump’s decisive victory and the Republican sweep of both the House and the Senate have reassured the markets, dispelled some of the uncertainty and brought much-need clarity for investors on the shape of the president-elect’s economic policy.

The essentially pro-growth measures promoted by Mr. Trump include deregulation, especially in sectors such as energy and finance, as well as further tax cuts by extending the tax breaks enacted during his first term and adding yet more reductions in corporate taxes. On the other hand, imposing higher tariffs, in a bid to boost American manufacturing by raising prices on imported goods, is an inflationary move that could negatively impact global growth.
Higher tariffs would hurt China and, by contagion, Europe, with Germany being the most exposed.

Solid nominal growth and higher inflation

Mr. Trump’s second term should be positive for nominal growth in the United States. US bond market inflation worries increased slightly over the past few weeks to settle around a manageable 2.4% on average for the next five years. The strong growth outlook has tempered expectations of rate cuts: the market is pricing in only three 0.25% reductions between now and the end of 2025. This more cautious approach to monetary easing has added to the recent appreciation in the US dollar.

Investors are not – yet – spooked by Washington’s soaring debt burden and its fiscal deficit which stands at 7% of GDP. America’s superior technological, military and energy might give it very considerable competitive advantages over the rest of the world, backed by the greenback as the world’s dominant reserve currency. Since the 2008 financial crisis, the country’s economic performance has been driven by a combination of rising productivity and demographics. Reaping the rewards of massive investment in technology, US labour productivity has grown by more than 30% in the period since 2008, more than three times faster than in the eurozone.

Weakened eurozone

With eurozone growth flagging, the political turmoil in France could further weaken business and consumer sentiment.

After Prime Minister Michel Barnier’s government lost the vote of no confidence in the French parliament, France not only faces an excessive-deficit procedure launched by the European Commission this summer, but also now finds itself without a budget for next year. Unsurprisingly, Emmanuel Macron has promised to move quickly to name a new head of government.

Since a temporary government shutdown is very unlikely, pressure on the cost of French government debt has been relatively muted. While it is true that the spread over German bunds has widened, the 10-year rate remains under 3%, which is around 0.5% below the peak reached in early July.

Walking a tightrope in this challenging environment, the European Central Bank is expected to continue its monetary easing policy with a series of cuts to bring interest rates down to 1.5% by the end of 2025.Damien Petit, Sales Director, Private Banking

While bringing the deficit back to the target 5% of GDP in 2025 now seems out of reach, it is urgent to get the budget back on a credible trajectory – without overly dampening growth. With the influence of populist parties on the rise, this is a complex and onerous task.

Walking a tightrope in this challenging environment, the European Central Bank is expected to continue its monetary easing policy with a series of cuts to bring interest rates down to 1.5% by the end of 2025. We can but welcome the Bundesbank president’s call for the next Berlin government to soften its spending rules and create more fiscal space for investment in infrastructure and defense in particular and stave off stagnation in the German economy.

Buoyant US markets

US equity markets reacted positively to Donald Trump’s election victory with prices rising some 6% in dollar terms. Growth in European and emerging markets since the US election result has been much more subdued.

US equities were buoyed by impressive growth in tech stock earnings. In our view US equities are fairly expensive on the basis of a number of absolute and relative measures. And it’s important to keep in mind that the link between valuations and performance only holds over the long term. Valuations in Europe look more attractive in comparison. However, since the European equities market is more cyclical in nature, an uptick in growth is needed to boost earnings and performance on the “old continent”.

Damien Petit
Sales Director, Private Banking