Any US tariff hike will alter prevailing inflation dynamic

We had called 2024 the ‘Year of Answers’ and last week was undoubtedly a very special one with the key US elections, not less than five central banks holding their policy meetings, and a critical session of the standing committee of China’s National People’s Congress.

This could have resulted in massive market volatility or have completely reshaped the investment landscape.

Spoiler alert, it didn’t.

Let’s start with the US elections. The great news is that last week brought a clear and undisputed result. This removes the risk of the massive spike in volatility that would have been triggered by disputes and uncertainty.

Second, with the White House, the popular vote, control of the Senate and likely also the House of Representatives, President-elect Trump and the Republicans have been given a loud and clear mandate to implement the measures on which they campaigned.

We can group them in two categories. Domestically, it’s about less regulation, lower taxes, as well as less immigration. This is clearly pro-business, with a potential direct impact on profits from lower corporate tax.

Overall, this is favorable to growth, even if a tightening on immigration could reduce demand and increase the cost of labor. Then, internationally, apart from his willingness to end as quickly as possible the conflicts in which the US is involved, President-elect Trump wants to put ‘America First’ with trade tariffs.

He mentioned universal tariffs for all imports, which could be 10-20%, and specific ones for China which could reach rates as high as 60%. This could hurt the rest of the world, but also, clearly, generate inflation within the US.

A cog in disinflation wheel?

This, in turn, could threaten the current ‘immaculate disinflation’ narrative from the Fed and limit their easing ability. Not great news for markets.

At this stage, it’s important to keep in mind that the single economic reason for which the Democrats lost the elections is inflation – both growth and employment were absolutely fine. There is no doubt that President-elect Trump is aware that any drift in inflation would be a considerable political risk for his party. He probably holds all the levers of power now, but the midterm elections are just two years away. For this reason, we tend to believe that he will be careful. The most inflationary measures may not be implemented automatically and radically.

Tightening immigration could focus on illegal aliens who could have committed offences or crimes, for example. With regards to tariffs, 60% on China looks way too extreme to us: this would hurt the US consumer and US businesses, as America does not manufacture all the ‘Made in China’ everyday items that are sold by Walmart or Amazon.

Tariffs are a threat, and a very effective lever for trade negotiations, as we saw in President-elect Trump’s first mandate. They are a double-edged sword as well. In the meantime, we expect to see deregulation, especially around energy and environmental topics, which will support businesses. The same applies to tax cuts, which raises the question of US fiscal deficits.

One unknown is to what extent government expenditures may also be cut, with Elon Musk being very vocal about it. Such a combination could have mixed immediate impact on growth and cyclical assets, but potentially strong long-term positives, as in the Reagan era.

Accelerated rate cuts?

We had lots of information to digest last week. Both the US Federal Reserve and the Bank of England cut their policy rates by 25 basis points, which was widely expected. They spoke about their respective political developments (US elections, UK budget) but didn’t seem to dramatically change their stance.

As a backdrop, global PMIs for October came in at overall very satisfying levels, confirming a very decent state of the global economy. Meanwhile, China failed to impress with the size of their fiscal stimulus plan, around RMB 10 trillion over the 2024-28 period.

Still, it is material, and we will always take Chinese authorities extremely seriously.

Taking everything into account, we do not think that the investment landscape has dramatically changed last week. Global growth remains solid, with US reinforced exceptionalism on one side and China’s stimulus in the other, even if the situation may be less enviable for Europe and Japan.

Global stocks’ valuations remain rich in absolute and relative to bonds, but earnings trends are so far intact, and a diversified portfolio should continue to do well. The main risk is actually inflation, which would damage most lines of any portfolio.

This is what we will be the most vigilant about in the coming months, when the new US administration will take office. In the meantime, with increased visibility on elections and no red flag on activity, the end of the year could confirm a great vintage for investments.