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Global Macro - EM EMEA prospects post US elections

A second Trump administration is set to bring US tariff increases (and the likelihood of retaliation action), much lower immigration, fresh tax cuts, regulatory easing as well as a marked increase in economic uncertainty. For the EM EMEA region, these anticipated headwinds are coming at a time of weakening sequential activity and inflation that is proving stickier than expected (especially in high yielding economies). Yet, the implications of tariff increases will be idiosyncratic. The brunt of the impact will be felt in the CEE region given the emphasis on auto tariffs via the Euro area interlinkages. For the Middle East, much will depend on what happens to oil prices (and volumes). In Turkey, the emphasis is on disinflation with the first-order implications from a Trump administrations being muted for now. For Russia and Ukraine, the election outcome has raised the spectre of a near-term negotiated ceasefire, with indeterminate reverberations of what comes next.

US Fixed Income: Post election, macro still matters

Macro View: Recent economic data point to continued underlying weakness in the labour market. October’s NFP was a massive downside surprise, showing only 12K jobs added along with downward revisions of 112K for the previous two months. In addition, this was the first decline in private payrolls since the pandemic where if it weren’t for government job gains, the headline would have been negative too. Strikes and hurricanes led to the less than stellar report, as captured by the 46K fall in manufacturing employment and the 512K who reported not being able to work due to bad weather, but while the strikes and hurricanes may point to temporary cracks in employment dynamics, the repeated large downward revisions to past months’ data point to more sustained underlying weakness remaining in the US jobs market.

As for the inflation picture, the October CPI report showed headline and core inflation increasing again by 0.2% and 0.3% month-over-month, respectively. Housing inflation came in a bit higher than expected at 0.4%, though the larger gain in OER is unlikely to be repeated, in our view. Meanwhile, apparel prices dropped back after a surprise gain last month. The big culprit this month was used cars and trucks, up 2.7% m/m, the largest in 16 months. However, a small decline in the Manheim Auction Price Index in October suggests that gain is only temporary. Unfavourable base effects meant that headline CPI rebounded to 2.6%. From a momentum perspective, it appears that short term improvements in inflation trends have stopped and at best we are stabilizing at still a higher run rate--especially on a three-month annualized basis. If it continues, this trend is something the Fed will likely consider for policy decisions in early 2025.

Fed view: In the second rate cut this cycle, the Fed cut rates by 25 bps at the November meeting, moving back to a standard pace of 25bp increments. The FOMC views the risks between their inflation and employment mandates as balanced, where they are well positioned to achieve their dual mandate by tweaking the normalization path if needed. Given the recent rise in overall rates (after the initial Fed cut and the post-election move), Powell said it was something the FOMC is watching but it’s too early to say where long-term rates will settle. He noted that the Fed does take financial conditions into account if persistent and material changes take place, but they are not taking them into account at this stage right now. He said it appears the moves are not principally about higher inflation expectations, but more so reflecting growth expectations and perhaps fewer downside risks with the election out of the way.

At the press conference, Powell emphasized that rates remain restrictive and finding neutral is a process. With the Fed’s policy rate still in the mid-to-upper 4% levels, it is likely too early for the Fed to start thinking about pauses. As such, we expect another 25-bps cut at the Fed’s December meeting. As of now, nothing in the presser suggested that the FOMC is taking future fiscal policy into account for near-term monetary policy decisions (as there is too much uncertainty in how fast fiscal policy may change). With the medium-term changes, the Fed probably pauses earlier as long as growth continues to come in well and the stock market continues to perform, either skipping at the January or March meeting to begin cutting at every other meeting. We also expect the Fed to start preparing to end QT by announcing it early in 2025 as well.

Election view: As for the recent US election, Donald Trump decidedly won the US Presidential election with both the popular vote and a large electoral college tally too. The House remained red (albeit with a minor majority) but the Senate flipped to Republican, meaning it was a trifecta red wave. Trump team has already begun nominating individuals for his cabinet positions. Now time will tell whether a.) all of his cabinet nominees go through (and how quickly versus his first term) and b.) what will be the turnaround time for the implementation of the proposed fiscal related policies (and will they result in more debt financing or will prior spending be adjusted lower). For example, Trump has already begun to organize an effort to reduce inefficiencies and bureaucracy in the federal government with the Department of Government Efficiency. At a minimum, this could be a signalling effect that the Trump administration doesn’t want to further burden what has been a system straddled with high debt loads.

FX Outlook

The USD has strengthened further since the last release of the Global Markets Monthly (28^th October), by 2.1% as market participants responded to the Donald Trump’s election victory that will see him sworn in to office on 20^th January. The USD has now strengthened by over 6% from the low-point in late September as markets began to anticipate victory for Trump. The move is approaching the scale of difference we had anticipated between a Trump vs Harris presidency (7-8%). We may now see the USD consolidate given we may have reached a new post-election equilibrium range for the USD. There is likely further to go in this move but clarity on scale and timing of trade tariffs will be important. Cabinet picks so far point to Trump choosing loyalty over experience and disruption over status quo that likely means higher levels of FX volatility ahead. We suspect the USD may peak in Q1 2025 and then weaken gradually as the economy slows, and the Fed cuts rates by a little more than what is currently priced.

USD/JPY - Neutral Bias - 148.00-160.00

EUR/USD - Bearish Bias- 1.0150-1.0850

USD/CNY - Bullish Bias- 7.1500–7.3000

 

KEY RISK FACTORS IN THE MONTH AHEAD

• One downside risks for USD/JPY in the month ahead would be stronger pushback against JPY weakness from domestic policymakers. If USD/JPY continues to rise quickly back up to the year to date highs it could trigger another bout of intervention from Japan to support the JPY and/or encourage the BoJ to bring forward plans to hikes rate again as soon as next month. Alternatively, if the BoJ sticks to plans not to hike again this year and USD/JPY moves higher at a more gradual pace it is less likely to be met by intervention.  
• The main upside risks for EUR/USD include: i) ECB getting cold feet over delivering the third back-to-back rate cut in December, ii) further evidence of a weakening US labour market that prompts the Fed to keep lowering rates ahead of the implementation of Trump’s policy agenda next year, and iii) any indication that the incoming Trump administration could potentially row back from the threat to impose tariffs of 10-20% on imports from the major trading partners of the US including the EU.
• The main upside risk for USD/CNY would be confirmation that Trump plans to follow through with plans to impose much higher tariffs of up to 60% on imports from China. It would hurt China’s exports and put additional pressure on China’s economy when domestic demand is still sluggish. This could also incur broader risks to the global economy including the US economy, as such action could push up US inflation, curtail US growth, and create negative spill-overs to other economies. In order to dampen capital outflows, Chinese policymakers could bring forward plans for bigger one off devaluation. In contrast, downside risks for USD/CNY include the announcement of much larger fiscal support in China, and the unwind of recent Trump trade if the tariffs likely to be imposed on China are not as bad as feared.

European Credit

Since early October there has been a relentless rally in the EUR credit markets with the aggregate Corporate index tightening around 18bp on z-spread. We are now back at levels seen last in January 2022 but still off the multiyear tights seen in June 2021 of z+82bp.

The overall EUR corporate IG index stands now at z100bp, down from z146bp in early January 2024. Overall credit yields have come in since the ECB started rate cuts, to around 3.2%, down from YTD highs of 4.15% in mid-June.

The recent oil prices have been at the lower end of a USD23 range at around USD68 and other risk indicators such as Bund-BTP spread has now tightened to 121bp, from the June wide of 158bp, and is now close to the 2 year tights of 117bp seen in October 24.

The election of Trump to the US presidency has boosted a divergence between US and European rates over the next twelve months. This appears rational given Trump’s agenda, which is seen as inflationary, and taking into account Europe’s relatively stagnant economy, as demonstrated by the expectation that Germany will post its second successive year of slightly negative economic growth. Nevertheless European credit continues to benefit from the market’s assumption that a soft landing remains the most likely outcome.

Political risk has been on the rise in the region, with the potential for political disruption in France and Germany, both coming at an inconvenient time, given the weakness in the economy and Trump on the horizon.

The Main at c.57bp, after having touched 51bp in September, remains close to its two year tight of 50.5bp

We maintain a neutral/constructive stance on European Banks and we retain a cautious stance towards European IG corporate credit at this juncture, with a preference for defensive sectors and higher quality credits over cyclicals and higher beta credits. Albeit we do scope for credit spreads to remain range bound to year end, as supply subsides from its current robust levels.