The three things investors should know ahead of today’s Presidential inauguration
Once in office, Mr Trump will face higher inflationary pressures, a jittery bond market, a debt ceiling negotiation and an obligation to roll a large part of US debt. Trade wars and a thin House majority may accentuate all of the above. Equity and bond markets celebrated slightly better than expected core CPI inflation numbers out of the US. However, that reaction is more about a market looking for a positive catalyst and less about an actual improvement in inflation. Equity markets do not seem to have priced-in adverse trade outcomes or high interest rates.The experiment is one of testing the full power of the Oval Office. Will Mr Trump convince bond markets as well? This is the key question for 2025.
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Summary
As Mr Trump takes office this afternoon, he will be faced with higher inflation, potentially accentuated by trade wars, and thus a higher cost of debt. Given the overall debt levels, the amount of debt to be rolled over in 2025 and fiscal needs to meet election promises, high (or possibly high-er) interest rates are not conducive. Against these pressures, as well as geopolitical challenges, Mr Trump intends to balance the full weight of the Oval Office. Will he convince bond markets the same way he has so far convinced equity markets? This is the big question for 2025.
Week ahead
The week will likely be monopolised by Mr Trump’s inauguration, and his first actions as US President, as well as the confirmation of various individuals for key offices. In other news, on Friday investors will gauge the global economy through flash PMI numbers, and the Bank of Japan will likely announce a rate hike to 0.5%.
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The afternoon of 20th January will find Donald Trump officially President of the United States of America. In the last few days, we have heard a lot about the new President’s plans: a precipitous hike in tariffs, deregulation in the bank, tech, energy and pharma sectors, reducing corporate taxes, a “cultural revolution”, ending global strife, rewriting global borders, ending illegal immigration… and so much more.
Planning is easy of course. But, as leaders almost always find out, once in office, the job consists mostly of putting out fires.
On his first day in office, the new President will find seven economic challenges that he will have to put out before he can advance to bigger plans.
Which are these?
1. Inflationary pressures
Despite better-than-expected numbers last week, US inflation is at 2.9%, almost 1% above target. It could have been higher if not for Chinese economic weakness. But numbers from last week suggest at least an economic rebound in China. The success of the previous stimulus measures could prompt the government to do more, which could reduce China’s deflationary effect on the world. Mr Trump’s tariff plan is inherently inflationary. Over the long term, it may bear fruit, but over the short term, it could put significant pressure on consumers and markets. To be sure, equity and bond markets celebrated slightly better than expected core CPI numbers out of the US. However, that reaction is more about a market looking for a positive catalyst and less about an actual improvement in inflation.
2. Bond market jitters
Since September, borrowing costs have risen by around 1 percentage point in many developed markets. This is already causing or accentuating political strife in France and Britain. Part of the responsibility should be borne by the Fed. The US central bank surprised markets in September by performing a double rate cut, sending a message that it would follow a loose monetary policy going forward. In the months that followed, economic data improved and Mr Trump’s aggressive trade agenda got the “go-ahead” from American voters, which cast doubts on the Fed’s loose policy message. Last September, markets priced in five to six rate cuts in 2025. Now, they are barely pricing in one to two.
3. Higher interest rates
As a result, the new President may have to contend with high interest rates. In the past month, the Fed has communicated that it does not intend to significantly reduce rates. Some market participants are talking about rate hikes. Higher rates will increase borrowing costs not just for consumers but also for the government. Already, interest payments for the biggest global economy are at 4.5%, eating away almost all of with nominal GDP growth (4.6%) Higher interest rates on debt mean less fiscal space or bigger deficits. The latter will mean even higher yields for US bonds (thus even less fiscal space). The IMF is expecting US debt-to-GDP to be at 131% by the end of the decade. The Republican Party has a lot of “fiscal hawks”, so the new President could find resistance to borrowing more and be forced to sacrifice part of his agenda.
4. The Great Debt Roll
Within 2025, especially in the second half, $7tn of debt will have to be rolled over. This is nearly a quarter of all US debt (almost 21 times the entirety of Greek debt). A choice of higher deficits to fund extra spending needs could create a supply glut, leading the US to borrow at higher rates for longer maturities, further upsetting bond markets and accelerating US debt accumulation.
5. A debt ceiling battle may test the President’s limitations.
The last budget moved the conversation for the “debt ceiling” literally on the first days of the new Presidency. Technically, the US can’t issue new debt since the beginning of the year, but the US Treasury has some wiggle room to make sure the government doesn’t run out of money for a few days. We believe that the debt ceiling battle may be contentious, but will likely end in an increase, much like it has in all the previous 50-odd times. However, Congress will likely ask for something in exchange, which is also typical in such discussions. The more protracted the debate and the bigger the President’s concessions, the more limits and checks to Presidential powers.
6. Momentum-less and unready equity market
Despite last week’s rebound, after what markets considered to be a positive inflation read, equity momentum has waned. Since equity markets began pricing in Mr Trump’s win, the tech sector, seen as a beneficiary, has again ploughed ahead, giving the impression of a roaring stock market. From mid-September, the “Magnificent 7” have advanced by 25%. But the rest of the US large caps are up 4%, more than half of which in 2 days. In the US, stocks are directly important for consumers, as 401Ks (the American version of a SIPP ), are inextricably linked to the stock market. Mr Trump scores himself on stock market performance. Trading at 27x its earnings, this market does not seem to have priced in either persistently high rates or the effects of sharp hikes in tariffs.
7. A thin House majority and a “thirsty” party.
In the past, the debt ceiling, budgets etc would not have been considered an issue when the party was in control of both chambers of Congress and the Presidency (not to mention the conservative proclivities of the Supreme Court) and the caucus was strong and united. But the Republican majority is very thin, and all it takes is a few congress members to derail a legislative agenda. The situation is accentuated by the incoming President’s practice of giving top positions to allies, instead of seasoned Congress members. This means that legislators, especially strong incumbents, have little to lose by pressuring the administration, stalling agendas, pushing for amendments etc.
In conclusion
A look at the above would suggest that President Trump’s problem is mostly centred around trade wars, which will, all other things being equal, mean higher interest rates at a time when fiscal space is limited, even for the United States. Mr Trump who is well-back by businesses, is weighing (“pitting” rather) the US businesses and the Office of the President’s power against that of all political foes, trade partners and bond markets. The prevailing narrative is that it is possible to impose tariffs without significantly increasing inflation, and that competitiveness is possible with a stronger US Dollar. That the global political and business world will agree to everything without much resistance and that geopolitical issues will be resolved through the threat of force. Voters, politicians and a large part of the Press, as well as some analysts, stand behind this narrative. The reaction of bond markets suggests that not everyone believes in these outcomes. Will Mr Trump be able to convince bond investors too? Is what Theodore Roosevelt called the “Bully Pulpit” enough to bring markets to heel? This is the biggest economic question of 2025.
