Eddy's Weekly Market Update
Following President Biden's rather lackluster performance during the CNN debate, Trump's chances have improved. What could it mean for economic policy if Trump and the Republicans win? Firstly, Trump aims to implement a 10% tariff on all imports. The revenue from this tariff would be used to lower income taxes. This combination is expected to drive inflation up, especially considering he plans to impose a 60% tariff on Chinese products. Additionally, this would result in a smaller trade deficit for the U.S. and consequently boost the dollar's value.
Furthermore, Trump intends to maintain the tax cuts that are set to expire in 2026 and reduce taxes even further, without significantly cutting spending. As a result, it's likely that under Trump, the budget deficit will continue to rise, remaining well above 6% of GDP. This means the national debt is expected to rapidly increase to 110% of GDP (a level above 90% is often considered dangerous). Republicans argue that a large deficit will spur economic growth, which in turn will increase tax revenues and eventually reduce the deficit. However, this theory has never been proven in practice. Instead, it often forces the central bank to adopt inflationary policies.
This scenario would lead to upward pressure on long-term interest rates, particularly in the U.S., but also to some extent globally. Notably, despite a low inflation figure released in the U.S. at the end of this week, long-term interest rates initially dropped but then started to rise again. There could be various reasons for this, but it might be seen as a warning sign.
Moreover, several Federal Reserve members immediately clarified that the low inflation figure does not mean that interest rates should be lowered in July. They want to see sustained low inflation and avoid a quick rebound, as many analysts expect. Likely, they are also considering the increased chances of a Trump victory, which does not bode well for inflation. Additionally, Trump has indicated that he plans to replace the current Fed chair in 2026 with someone who favors keeping interest rates low.
Another political event to watch is the elections in France this and next weekend. It is likely that Ms. Le Pen's party will form a new government. This is unfavorable in two ways:
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Given that the spread between German and French interest rates has already widened significantly, if a new government implements its plans, the spread will increase even further. This could lead France towards bankruptcy, forcing the government to backtrack, similar to what Ms. Meloni did in Italy. The major issue is that Europe faces significant challenges in defense, climate change mitigation, and its geopolitical position. Addressing these requires substantial funding and a united approach from European countries. The rise of the far-right across Europe complicates this, and issuing bonds backed by all participating European countries would be necessary for financing. However, Germany has indicated it is not willing to do so as long as there is a French government pursuing its current program.
Conclusion: In Europe, growth is slowing and inflation is declining, increasing pressure on the ECB to lower interest rates as soon as possible. This also applies, though to a lesser extent, to the U.S., but the prospect of a Trump victory will make the Fed very cautious about lowering rates. This is positive for the dollar relative to the euro, especially since Europe is heading in a political direction that undermines confidence in the euro. Despite a stronger dollar, we remain positive on gold (see our recent gold report for more details).
For the impact on other markets, I refer to our Global Financial Markets Report from Friday, June 28th. If you would like to receive a copy, feel free to send me a DM with your email address - and I will make sure that you receive the report in good order.
Have a pleasant week ahead.
With kind regards,
Eddy