The “red wave” sparks enthusiasm

While the triumph of Donald Trump and the Republican camp gaining full legislative powers is celebrated on Wall Street, the bond market’s reaction is more measured. Coinciding with Donald Trump’s rebound in the polls, the correction endured in October foreshadowed the “red wave” that swept through last week. Although widely expected, this scenario had little impact on dollar yields. After a nervous episode during election night, the yield on the 10-year T-Note returned to the neighbourhood of 4.3%.

Beyond Donald Trump’s election promises and rhetoric, the new administration and the Republican majority will be judged on their actions and their consequences for growth, inflation and public finances. On the trade front, a protectionist shift could be implemented quickly and revive inflation. However, this effect is likely to be temporary, as import taxes are only partially passed on to final prices on a one-off basis. A tightening of migration policy and the deportation of “illegal” workers could also have an inflationary effect, but it is possible that Donald Trump will prove more pragmatic in office than in his campaign to win over the working classes.

When it comes to the budget, Donald Trump could face some resistance from Congress. Although the Republicans have a majority in both chambers, the GOP has many members who want to reduce the weight of the public sector. Some tax cuts may be rejected, and the Libertarian wing will seek to reduce public spending.

The risk of interference with the Federal Reserve also poses a threat to the bond market. However, the central bank’s U-turn in September and last Thursday’s 0.25% cut in the Fed funds rate are likely to ease tensions between Jerome Powell and Donald Trump. The pre-emptive easing of monetary conditions serves the new president’s interests, but this convergence could be undermined in the not-too-distant future if renewed inflationary pressures lead the FOMC to interrupt the rate-cutting cycle.

Donald Trump’s return to the White House entails serious risks for dollar-denominated bonds, but these risks are now being rewarded with decent real and nominal yields that are far from justifying an aggressive underweighting of bonds at a time when equities are peaking at all-time highs on the back of AI promises and a new era of “Trumponomics”.

On the euro capital market, yields are falling again. Far from the hopes raised by the “red wave” in the USA, the eurozone seems unfit to meet the geopolitical and economic challenges ahead in an unstable and fractured world. A few months after France, Germany too is experiencing a political crisis likely to hamper the reforms and fiscal stimulus measures needed to revive a weakened economy. In the UK, the Bank of England cut its key rate to 4.75% and reaffirmed its commitment to a gradual normalization of monetary conditions. In Switzerland, yields remain under pressure in anticipation of a further SNB rate cut in December, while annual inflation fell to 0.6% in October.