Holding One’s Breath
- 04 November 2024 (10 min read)
Poll aggregators suggest that the US presidential race is very tight, but the change in dynamics – Harris’ national lead has been shrinking slowly since mid-October, and Trump is now seen in the lead in 5 out of 7 swing states, albeit with tiny margins – combined with the memory of the polls’ understatement of voting intentions for the Republican candidate in 2016 and 2020 has pushed the market into pricing quite clearly a Trump victory. Collectively, investors seem to agree with the notion that a Trump 2.0 administration would come with more inflation and a higher deficit – we concur. This results in a rise in US long-term yields and an upward revision in the market’s expected trajectory for the Fed even in the absence of new significant macro data.
We explore once again the main macro policy issues at stake here (regulation, immigration, trade, fiscal policy, and the possible erosion of the Fed’s independence), with the help of a remarkable, quantified paper by the Peterson Institute which tackles three out these five issues. The paper largely confirms our view that, taken in isolation, a 10% hike in US tariffs would be manageable by the rest of the world, especially if monetary policy is allowed to play its stabilisation role, adopting a more hawkish stance in the US and a more dovish one elsewhere. However, we disagree with the mostly benign assessment of the impact of a 60% tariff hike on imports from China on third countries. We do not think that in such configuration we could count on a relative stability of the yuan. The temptation of depreciating the currency aggressively would become very difficult to resist in Beijing, with significant knock-on effects on Europe. We also highlight the importance of the contagion effects from a dominant US bond market in case of additional fiscal drift. This calls for even more readiness to act, if need be, by the ECB.
While the US elections leaves of course little bandwidth, we also explore the UK budget unveiled last week. The market reaction was measured, but we feel a chance to build a mutually beneficial trade-off between fiscal and monetary policy has been missed there.
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