Donald Trump’s recent victory in the United States (US) presidential election has prompted a wave of market reactions, dubbed the “Trump trade”. The Trump trade is rooted in a combination of expected fiscal stimulus, deregulation, and protectionist policies that are projected to spur United States’ (US) growth and inflation.
Trump’s policy framework includes proposals for significant infrastructure spending, corporate tax cuts, and rollbacks in regulatory constraints, particularly in sectors such as energy and finance. These measures have fuelled expectations of a reflationary environment where increased government spending could catalyse economic growth. In anticipation of these changes, US bond yields have risen sharply, reflecting the market’s expectation for higher inflation and, consequently, higher interest rates.
As inflation expectations rise, so does the probability of higher long-term interest rates, making the cost of capital rise globally. These factors create a dual dynamic: a stronger dollar driven by interest rate differentials and a flight to US assets as investors seek safety in what they perceive as a growth engine.
Effects on interest rates and inflation
The expectation of higher US inflation has led to an upward adjustment in US Treasury yields. The 10-year US Treasury yield, an indicator for global interest rates, has climbed significantly since Trump’s election. This increase reflects a broad-based adjustment in the market’s view of future inflation, particularly as Trump’s fiscal stimulus plans are expected to raise aggregate demand, placing upward pressure on prices.
With higher inflationary expectations, the US Federal Reserve (Fed) will likely adopt a more hawkish stance to prevent the economy from overheating. This scenario creates an environment where interest rates will likely rise over time or remain higher than expected. Higher interest rates, in turn, bolster the US dollar as investors flock to dollar-denominated assets for better returns, creating a self-reinforcing cycle where both interest rates and the dollar rise in tandem.
The dollar and emerging markets
One of the most immediate and visible effects of the Trump trade has been the strengthening of the dollar, which poses a challenge for emerging markets (EMs). A stronger dollar makes it more costly for EM countries to service their US dollar-denominated debt, increasing the financial strain on economies grappling with external vulnerabilities. Countries with large current account deficits, like Turkey and South Africa, are particularly susceptible, as they rely on foreign capital inflows to finance their deficits. When the dollar appreciates, these countries experience increased outflows as investors withdraw their funds to take advantage of higher returns in US markets.
In response to the dollar’s ascent, EM currencies have depreciated, with some facing substantial losses. This depreciation exacerbates inflation in these economies as imported goods become more expensive, forcing EM central banks to consider rate hikes. These rate increases are often done to protect their currencies but can come at the cost of slowing economic growth. The dilemma for many emerging economies is balancing the need to maintain currency stability while avoiding contractionary policies that could stifle growth.
European markets: challenges and opportunities
In Europe, the Trump trade has presented many opportunities and risks. The immediate impact has been the euro’s depreciation against the dollar, as the greenback has surged on rising US yields. A weaker euro can benefit European economies, making European goods more competitive globally and potentially growing European exports. However, this currency depreciation also poses inflationary risks as imported goods, particularly energy products, become more expensive.
From a monetary policy perspective, the European Central Bank (ECB) faces a delicate balancing act. While the eurozone’s economy has shown signs of recovery, it remains fragile and reliant on accommodative monetary policy. The ECB has maintained low interest rates and an asset purchase programme to support growth and stimulate inflation. However, with US yields rising, there is concern that the divergence in monetary policies between the Fed and the ECB could lead to capital outflows from Europe, pushing the euro down further and complicating the ECB’s policy stance. Additionally, a stronger dollar and tighter US monetary policy could pressure European bond yields to rise, making financing more expensive for European countries with higher debt levels, such as Italy and Spain.
The Trump administration’s protectionist rhetoric and policies aimed at restoring US manufacturing may reduce trade with emerging economies in the European Union (EU), many of which are heavily reliant on exports to the US market. These policies could dampen global trade, further constraining the growth outlook for the EU’s emerging markets.
Japan: impact of a stronger dollar and yield divergence
For Japan, the Trump trade has led to a considerable strengthening of the dollar against the yen, a development that generally favours Japanese exporters. Like Europe, a weaker yen makes Japanese goods more competitive globally, benefitting significant corporations such as Toyota, Sony, and Panasonic. This exchange rate shift has the potential to bolster Japan’s export sector, which has been a critical growth driver for an economy with limited domestic demand growth.
However, the Bank of Japan (BoJ) faces challenges in managing the impact of US rate hikes and rising US bond yields. Under its yield curve control policy, the BoJ has committed to keeping the 10-year Japanese government bond yield near zero. This divergence in yield policies with the US has led to capital flows out of Japan as investors seek higher returns in the US. These dynamics put pressure on the BoJ to either increase its bond purchases to maintain its yield target or risk seeing yields rise, which could tighten domestic financial conditions and hinder Japan’s economic recovery.
Shifts in global bond markets and the carry trade
The ripple effect of rising US bond yields has significant implications for global bond markets, with investors adjusting to a more inflationary outlook in the US. Rising yields make US bonds more attractive relative to other markets, leading to a sell-off in global bond markets as investors move capital to higher-yielding US assets. This shift has led to an uptick in yields globally, with government bonds in developed markets like Germany, the United Kingdom (UK), and Canada also experiencing upward pressure.
The stronger dollar and rising US yields have impacted the “carry trade” – a popular investment strategy where investors borrow in low-interest-rate currencies (like the yen or euro) to invest in higher-yielding assets. With the dollar appreciating and US yields rising, the attractiveness of the carry trade has diminished, especially as the cost of funding in foreign currencies becomes less favourable. This trend has led to capital being repatriated from riskier markets, impacting global liquidity and potentially tightening financial conditions worldwide.
Recalibration
The Trump trade has brought about a global recalibration. While a stronger dollar and rising US yields may benefit certain sectors within these economies, they also present risks in terms of capital outflows, inflationary pressures, and potential trade disruptions. The divergence in monetary policies between the US and other major economies further complicates the outlook, particularly for central banks like the ECB and BoJ, which may be forced to adapt their policies in response to changing financial conditions.
MARKET MOVES
Bonds
The yield on the US 10-year Treasury note fell below 4.4%, down from an earlier high of 4.48%, as traders assessed recent economic data and policy directions. While US producer prices met expectations, the annual rate exceeded forecasts. Wednesday’s Consumer Price Index (CPI) report met expectations and boosted hopes for a December Fed rate cut. Currently, there is a 79% probability of a 25-basis point US rate reduction next month, down from 86% before the Producer Price Index (PPI) release. Speculation about inflationary pressures under a potential Trump administration, including tariffs and tax cuts, has investors looking to Fed Chair Jerome Powell’s remarks for guidance on the Fed’s December outlook.
The UK’s 10-year gilt yield settled at 4.5%, with British wage growth slowing to its lowest rate in two years, aligning with the Bank of England’s (BoE’s) outlook on easing inflationary pressures. The BoE recently cut rates for the second time since 2020, citing that the Labour government’s budget would push inflation and economic growth higher. Persistent inflation has led the BoE to ease cautiously compared to the eurozone and US. Markets are betting on a 15% chance of a December UK rate cut, while investors consider Trump’s policies, which may drive US inflation and impact Fed actions.
Equities
US stocks saw modest declines on Thursday, breaking from the post-election rally which pushed indices to record highs. The S&P 500 and Nasdaq 100 each fell 0.6%, while the Dow dipped over 200 points. Markets were responding to data releases showing October’s producer prices rose 0.2% month-over-month, aligning with forecasts, and jobless claims reaching their lowest level since May, indicating strength in the US labour market. Thursday also saw investors waiting for Fed Chair Powell’s speech to gather further clues on policy direction later in the day. Last night, Powell indicated that the Fed is in no rush to cut interest rates. Declines were led by industrials, particularly aerospace and defence, with industrial conglomerate General Electric Company and multinational aerospace and defence conglomerates RTX, and Lockheed Martin among the biggest losers. American technology company Cisco Systems dropped 2% on a weaker revenue outlook, while mass media and entertainment giant Disney rose 6.2% on strong earnings.
The UK’s FTSE 100 climbed 0.5%, buoyed by luxury goods company Burberry’s gains following the release of a new strategy focusing on core products and more accessible pricing. Burberry’s shares jumped 18.6%, marking its largest gain to date. Multinational insurance company Aviva rose 4.5% after reporting a rise in insurance premiums, and water and waste-water utility United Utilities gained 3.4% on projected revenue growth. Conversely, the precious metals and mining sector fell 1.9% as gold prices declined due to a stronger dollar.
Germany’s DAX rose 1.4% after two days of losses as investors weighed global inflation and central bank responses. Industrial technology company Siemens led gains, rising 4.9% after reporting stronger-than-expected profits, while telecoms giant Deutsche Telekom added 3.3% on improved earnings forecasts. Meanwhile, global healthcare company Merck declined by 3.4% despite solid earnings, impacted by prior drug trial setbacks and a cautious 2024 sales outlook.
Commodities
Brent crude oil held around $72/barrel, influenced by the International Energy Agency’s forecast of a potential oversupply in 2025 if the expanded Organization for the Petroleum Exporting Countries, OPEC+, goes ahead with planned production increases. China’s oil demand, a major driver over the past two decades, has declined for six consecutive months and is expected to grow at only 10% of 2023 levels this year. The dollar’s recent strength has also weighed on oil, increasing its cost for global buyers. Oil prices have fallen 11% since early October, with traders awaiting next month’s OPEC+ meeting for potential production adjustments.
Gold dropped below $2,560/ounce, marking its fifth consecutive decline to an eight-week low as strong risk appetite and a rising dollar reduced demand. Concerns remain that Trump’s proposed tariffs and tax cuts could fuel inflation and impact the Fed’s rate cut path. Recent CPI and PPI data suggest US inflation is under control, though price growth in shelter and services sectors remains a concern.
Currencies
The US Dollar Index reached 106.9 – its highest level since November 2022 – as investors awaited a speech from Fed Chair Powell and analysed producer price data that slightly exceeded expectations. Optimism about President-elect Trump’s proposed policies, including higher tariffs and stricter immigration measures, boosted the dollar amid expectations that these could increase inflation and potentially slow the Fed’s rate-cutting plans.
The euro dipped below $1.06/€, its lowest level since October 2023, pressured by the stronger dollar and concerns over possible US trade tariffs that might hurt European exports, especially in the automotive sector. Political uncertainty in Germany, with snap elections scheduled after the collapse of German Chancellor Olaf Scholz’s coalition government, added to the euro’s decline.
The pound fell to $1.26/£, a three-month low, as the robust dollar and expectations of rising US inflation influenced currency movements. Recent UK labour market data showed only a slight easing in wage growth, supporting the BoE’s cautious stance on further interest rate cuts. The unemployment rate edged up to 4.3%, and job vacancies dropped to their lowest level since May 2021.
Key indicators:
GBP/USD: 1.2664
GBP/EUR: 1.2016
GOLD: $2,556
BRENT CRUDE: $71
Sources: Bloomberg, Reuters, AP News, IMF Research Department, World Bank, European Central Bank, Bank of Japan, Refinitiv and Trading Economics.
Written by Citadel Advisory Partner and Citadel Global Director, Bianca Botes.
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