Weekly Update - United States: Inflation as the flipside of the Trump Trade?

United States: Inflation as the flipside of the Trump Trade ? US equity markets welcomed the election of Mr Trump and the victory of the Republican Party to both houses of Congress, counting on tax reductions. However, the implementation of its economic programme carries a real risk in terms of inflation, in a context where inflation has not yet fully returned to its target level of 2%. Such a risk could even force the Federal Reserve to pause its rate-cutting cycle.
 
Equity markets in great shape after the election. While opinion polls showed a very tight race, the speed with which the result was confirmed and its decisiveness were reflected in a strong rise in the US equity markets. Indeed, since November 6, the S&P 500 has risen by 4.8% while, in Europe, the STOXX 600 fell by 1.6%. While the reduction in political uncertainty explains this performance, Mr. Trump's program includes a very favourable tax system for companies and households, with the extension of cuts in household tax rates voted in 2017 and a further reduction in the tax rate on profits from 21% to 15%. In addition, Trump's agenda includes a reduction in regulation, particularly for the energy and financial sectors. These policies come at a time when corporate profitability is already high
 
An inflationary risk to be monitored. The full implementation of Mr. Trump's economic programme, however, involves at risk of a return of inflation. First, the significant increase in tariffs on goods would result in higher prices for goods. However, the deflation of durable goods is one of the explanations for the moderation in inflation in recent quarters. In addition, the restrictive policy on immigration could also increase the risk of inflation. Indeed, since the Covid crisis, the labour force has increased significantly in the United States thanks to migration flows. These flows have helped to reduce imbalances in an overheated labour market, and thus moderate wage and core inflation growth. Thus, a restrictive migration policy would risk reintroducing imbalances in the labour market, causing a return of wage pressures. Thus, these two measures (customs duties and migration policy) could lead to an intensification of inflationary pressures.
 
Bond markets are starting to price in inflationary risk. This potentially inflationary scenario comes at a time when disinflation in the United States is slowing. Indeed, the headline inflation index stood at 2.6% year-on-year in October while core inflation remained at 3.3%. Over the last 3 months, core inflation remains above 2% due to the slow normalisation of rent and implied rent inflation as well as inflation on certain services, such as insurance, which remains above its pre-Covid level. Bond markets have begun to price in this risk of higher inflation, with government bond yields rising from 3.8% to 4.5% between October and November. Money markets are now pricing in only three 25 basis point interest rate cuts by the Federal Reserve (Fed) by the end of 2025 compared to six priced in at the beginning of October. For our part, we believe that the Fed will continue its cycle of interest rate cuts in the coming months, as real interest rates are high and the labour market moderates. However, it will remain attentive to a return of inflationary pressures, once the first measures are put in place.

Other highlights of the week
 
In the highlights of the week, we chose to talk about the economic conditions in China as well as the GDP growth in the United-Kingdom :
 

• China: a mixed outlook Activity and trade data continue to show mixed prospects. Indeed, retail sales in October surprised to the upside, with an increase of 4.8% year-on-year, thanks to consumer subsidies. However, industrial production in October and investment spending showed below-expected growth, still under the weight of the real estate adjustment. In line with these data, the October trade surplus surprised sharply to the upside, due to a contraction in imports reflecting weak domestic demand.

• United Kingdom: weak GDP growth figure but positive details Q3-24 GDP growth was 0.1% quarter-over-quarter, below the 0.2% expected by consensus. However, the composition of growth shows a more constructive picture. Indeed, the change in inventories contributed significantly to the negative surprise in GDP. Domestic demand increased by 0.6% Q/Q, with positive contributions from household consumption and investment. This data should lead the Bank of England to maintain its key interest rate at 4.75% in December.

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