Red Sweep! Your Top Questions Answered......
Former President Donald Trump is the new US President-Elect, and the Republicans have completed a Red Sweep controlling both the Senate and the House of Representatives.
Trump’s win might lead to new US import tariff increases. An extension of the 2017 tax cuts and further fiscal stimulus are expected in a Red wave scenario. The medium-term impact is likely to be negative on the US economy and lead to higher inflation, and potentially also weighing on the Eurozone. It is unlikely the Federal Open Market Committee will react to the election result, but we could see an increase in terminal rate, given the upside inflation risk. Equity markets and the dollar have reacted positively. Yields were up in the US and modestly lower in the eurozone.
What are the possible economic impacts?
Trump’s victory will very probably lead to a new round of US import tariff increases. The potential extension of individual tax cut and further corporate tax cut are expected in a Red wave scenario. In the short term, these stimulus measures would boost US economic growth and corporate earnings. However, we think in the medium-term, they are likely to lead to higher inflation. Tariffs are likely to have bigger effects globally than the potential changes to fiscal and immigration policy.
How does it impact central bank policy and rate cuts?
The outcome of the US election may result in the Fed pausing the rate cutting cycle earlier than we had initially expected, as inflation may increase in late 2025. For now, the Fed will not change its plan as it bases its policy on incoming data. So, the plan to cut rates in December and at a quarterly cadence in most of 2025 is still valid in our view.
We think that the Fed will pause its rate-cutting cycle in September 2025, and reach a terminal rate of 3.75% ( vs 3.25% in our previous scenario).
In the eurozone, disinflation is well underway, and the ECB is facing a risk of losing economic momentum. We therefore see a higher probability of a relatively deeper rate cutting cycle.
We now forecast an ECB terminal rate at 2% that should be reached in September 2025, as opposed to 2.25% in the previous scenario.
Bond Markets
As for yield targets, we revised our US treasury yield targets higher given the inflation risk in the US and the risk of increased fiscal spending that would suggest more Treasury supply.
We see the US 10-year yield at 4.25% in 12 months (previously 4%), and stay Neutral on government bonds.
Regarding corporate bonds, the Red sweep is the perfect scenario for Credit as it implies easier regulation and lower corporate tax. Corporate credit may test new cycle lows in the US. In Europe, the Red sweep is not Credit-positive given the potential tariffs and geopolitical uncertainty. We do believe, however, that this is at least partially priced in, and we do not expect Trump to impose as many tariffs as threatened. The technical backdrop remains very supportive.
We stay Positive on both EUR and USD Investment Grade corporate bonds, and Neutral on High Yield corporate bonds (valuations are very tight).
In Emerging Markets, fundamentals are sound, and the carry is elevated. However, the expected expansionary US fiscal policy will generate higher US bond yields, and the central banks' policy divergence augurs well for a stronger dollar. These two factors are not positive for EM bonds. In addition, potential tariffs and trade tensions will harm EM exporters.
Hence, we turn Neutral from Positive on EM bonds.
How do the central bank policies impact FX?
The main driver for the coming month will be the interest rate differential. As mentioned above, the policy rate of the US central bank is now expected to stabilise at a higher level than our previous outlook. In addition, the ECB will probably cut rates by more than expected. This would imply a much higher rate differential in favour of the USD relative to the euro.
Hence, we revised down our EUR/USD target to 1.06 for the 3 month and 1.02 for the 12-month horizon.
We have also revised our outlook for the Japanese Yen to 150 (value of one USD) for both our 3- and 12-month targets. The Bank of Japan is still expected to increase its policy rate. Nevertheless, given our previous mention that the Fed terminal rate is now seen to be higher than our previous outlook,
The Yen should remain broadly stable at around current levels.
We have also revised USD/CNY targets to 7.20 and 7.30 (value of one USD) for the 3- and 12-month horizons.
Likewise, various other currencies against the USD pairing has also been revised given the stronger dollar view.
How does the US elections outcome impact our view on equites globally?
US Equities
Following the Red sweep, we should see the implementation of many (or all) proposed fiscal stimulus packages, including tax cuts and deregulation. It is worth keeping in mind that Small & Mid-Caps have a higher gearing to low corporate tax rates, because, among other factors, their effective tax rate is currently above levels for large caps.
If we combine this with a policy mainly focused on the domestic economy, we see the stars aligning for a more sustainable move from still rather expensive US mega caps to more reasonably priced areas of the market.
We thus stick to our relative preference of Small & Mid-Caps over the S&P500 equally weighted and over the S&P500 market weighted.
Since the aforementioned policy should also help drive manufacturing PMIs higher, we continue to like cyclical stocks with domestic exposure. Financials are our key sector conviction in the US as the sector should benefit from a “higher for longer” rates environment and ongoing deregulation.
European Equities
Given the recent development, we have downgraded European equities to Neutral.
Prospects for Europe have worsened materially recently. The threat of a reacceleration of global trade tensions is jeopardising our view of a growth recovery.
Germany, a key country in the eurozone, will also be occupied with domestic issues in the coming months with the breakdown of the German leading coalition. Hence, a coordinated European response to any US demands may seem more complicated going forward.
Europe would also likely suffer from escalating trade tensions between the US and China.
While our base-case scenario neither assumes a global 10% tariff rate nor a 60% tariff on China, the uncertainty stemming from the threat could hinder investments.
Earnings reported by European companies have been mixed so far.
While free float market cap-weighted earnings results have come in 3.7% ahead of consensus, earnings revisions breadth remains negative. The impact is particularly severe for China-related sectors such as automakers, luxury goods, and commodity producers. This is important as it puts the expected earnings growth for 2025 at risk, particularly as a 0.1 ppt sales-weighted GDP reduction could cause STOXX 600 earnings to fall by 1ppt.
Within Europe, we favour the UK and see value in the periphery countries as well as the Nordics, especially Sweden.
China Equities
We remain cautiously optimistic in the medium term due to three reasons.
i) there is still room for more fiscal stimulus.
It is likely that Beijing will prefer to introduce further stimulus in the 2025 budget after Trump’s inauguration;
ii) the 60% tariff on China is not our base-case scenario.
Like Trade War 1.0, it could be Trump’s trade tactics for a trade deal (it may take less time to reach a trade deal in Trade War 2.0), and
iii) the China market could still be volatile in the short term, but we expect domestic A-shares to be more resilient than offshore China equities because of the ongoing capital market reform.
Furthermore, the swap facility from the stimulus package announced in September has been working well to improve market liquidity and to encourage inflows into the A-share markets.
What does this mean for Commodities?
President-elect Trump has promised to support US oil and gas exploration (including shale oil & gas), by rolling back regulation and speeding up permit-granting procedures. This will further increase the country’s already record-high oil and gas production.
While this offers positive volume growth prospects for US energy companies, it could entail additional pressure on oil prices in an already challenging supply-demand situation. Remember that global demand growth remains very slow, partly due to the energy transition.
This prospect of further growing US supply comes on top of OPEC’s intention to gradually increase its production again.
In recent years, OPEC+ had cut its production by 5.8 million barrels per day (or +/- 10% of its capacity) to support prices. But this was compensated by growing supply by non-OPEC countries, mainly in the Americas. OPEC+ is not willing to extend its production cuts forever, as they want to recoup market share.
The start of its planned tapering process has already been extended from October 2024 to January 2025 in view of recent pressure on oil prices. At their next meeting on 1 December, OPEC+ may still decide on further extensions or the pace of tapering production cuts.
A full extension until the end of 2025 is rather unlikely. Very gradual tapering, coupled with more discipline from some members, could be a feasible outcome for the oil market.
Ahead of this crucial OPEC+ meeting, we remain Neutral on the Brent price with a target range of USD 70-80. But the downside risks are increasing, certainly in the event that OPEC+ ramps up its production too fast or does not reach a convincing agreement (or lack of discipline). Although the Chinese stimulus package could support Chinese oil consumption next year, we expect limited global demand growth over the next few years due to the energy transition.
Conclusion
The US election outcome is a game changer
The effect on US growth should be positive in the short term but mixed to negative in 2026. More stimulus and tariffs should push up US inflation next year. Lower uncertainty and a possible end to the conflicts in Ukraine and the Middle East could have a positive impact on world growth (via lower energy prices and improved sentiment) over the coming months. In the medium term, we can expect a negative effect due to tariffs.
Central banks and bond markets
The Fed should pause its rate-cutting cycle in September 2025 with a policy rate of 3.75%. For the ECB, we forecast a terminal rate of 2% to be reached in September 2025 (2.25% in the previous scenario). We see the US 10-year yield at 4.25% in 12 months (previously 4%), and our 12-month target on the Germany bund yield remains unchanged at 2.25%. We turn Neutral from Positive on EM bonds.
Currencies
The higher rate differential suggests renewed USD strength. We have revised our USD targets in general and the EUR/USD target to 1.06 for the 3-month and 1.02 for the 12-month horizon.
Equities
We have upgraded US equities to Overweight and downgrade European equities to Neutral. Within Europe we still favour the UK and see value in the periphery countries as well as in the Nordics, especially Sweden. We continue to like cyclical stocks, with domestic exposure. Financials are our key sector conviction in the US.
Commodities
We remain Neutral on the Brent price with a target range of USD 70-80. But the downside risks are increasing.
