From the performance of the financial market, the first week after this year's US election is undoubtedly historic - the market seems to have not fully factored in expectations of Trump's victory or Republican red tide before the election.
Therefore, people can see that the three major stock indexes in the United States have further set historical highs after the selection, with Bitcoin even approaching $90000 and investment grade bond spreads reaching the narrowest level since 1998. It is obvious that the market's risk appetite sentiment is very high - at least for now.
So, besides the comprehensive fluctuation of short-term market trends, what other insights can we gain from the results of this US election for the future direction of the economy and financial markets?
In a recent research report, Henry Allen, a strategist at Deutsche Bank, listed the "four key points" that investors should pay attention to after the election (some of which may actually make investors more cautious). Here, let's take a quick look:
Key point 1: Inflation risk will further increase
Allen predicts that inflation risks will further increase due to the potential tariffs and fiscal stimulus measures that Trump may implement. In addition, central banks around the world are currently implementing loose policies, while economic growth data has unexpectedly improved. Therefore, inflation will be a prominent concern that may prompt the Federal Reserve to adopt a more hawkish response.
It is worth mentioning that Deutsche Bank has been warning of inflation risks in recent months, and since the bank issued a reminder report in September, the 2-year US inflation swap has risen by nearly 50 basis points.
Here are four reasons why Deutsche Bank believes inflation risk will further increase:
The first reason is tariffs. Obviously, it remains to be seen how these tariff measures will be implemented and to what extent they will be subject to negotiation first. But Trump has been calling for increased tariffs during the campaign, far beyond the level of his first term, including tariffs on all imported goods. The full implementation of tariffs may increase the core inflation rate in the United States by 0.75 to 2.5 percentage points.
The second reason is fiscal stimulus, as the extension of Trump's first term tax cuts (which will expire at the end of 2025) will further increase demand, especially if further tax cuts are implemented on this basis. In fact, people can see how Biden's fiscal stimulus measures in the 2021 US Relief Act have led to rising inflation, especially in economies that have faced supply constraints after the COVID-19 epidemic. Compared to when Trump won his first election in 2016, the current unemployment rate in the United States is lower and inflation is higher, so on the surface, there seems to be less idle capacity in the economy.
Thirdly, the current inflation risk is already very high, especially as global central banks are relaxing policies and money supply growth is accelerating. The Federal Reserve has lowered interest rates by 75 basis points since its September meeting, and we know that monetary policy operates with lag, so the impact will continue until next year. In addition, Federal Reserve Chairman Powell himself stated last week that "our basic expectation is that we will continue to gradually lower interest rates to neutral levels. From a historical perspective, it can be inferred that when the central bank relaxes its policies, it is often the time to be cautious, as inflation may rise again as a result.
Fourthly, since the market turbulence this summer, the overall data from the United States has been surprising. For example, in October, the ISM Service Industry Index reached its highest point in two years, 56.0. The unemployment rate has decreased by 0.2 percentage points since its recent high in July. The overall market conditions remain very loose, with the S&P 500 index hitting a historic high and credit spreads reaching their narrowest level in years.
Allen believes that the risk of rising inflation is not a groundless concern, and some investors have already realized this. In fact, as of the close of last Friday, the two-year inflation swap in the United States has risen from the recent low of 1.98% on September 6th to 2.62%.
Key point 2: The current financial environment is completely different from when Trump won his first election in 2016
Allen said that the current financial environment is completely different from when Trump won his first election in 2016. Due to the rise in US Treasury yields and the increase in federal debt, the fiscal sector has become more constrained, and asset valuations are also much higher. Although many people are borrowing strategies from 2016 to analyze what is happening, the reality is that the situation in 2024 will be different.
Firstly, the current fiscal sector in the United States will face more restrictions. The federal debt level has significantly increased, and the Congressional Budget Office predicts that the US debt to GDP ratio will soon exceed the highest record since World War II. In addition, both nominal and real yields have increased, resulting in higher borrowing costs now compared to eight years ago. For example, the actual yield of 10-year US Treasury bonds closed at 1.94% last Friday, while at the end of the week when Trump won in 2016, it was only 0.25%.
Secondly, market valuations are being calculated from a higher base, so theoretically, achieving a rapid increase is more difficult than in 2016. In terms of stocks, the S&P 500 index actually fell by 0.7% in 2015, while in 2016, as of the end of October of that year (shortly before Trump's victory), the index had only risen by 4.0%. In contrast, the S&P 500 index rose 24% in 2023, and as of the end of October, the index has risen another 19.6% this year. The CAPE (Cycle Adjusted Price to Earnings Ratio) was 26.54 times in October 2016, but had risen to 36.85 times in October 2024.
As of last Friday, the spread on US high-yield bonds had dropped to only 256 basis points, the lowest level since June 2007 (before the global financial crisis). In addition, the spread on US investment grade bonds is only 74 basis points, the lowest level since May 1998.
Thirdly, inflation was not considered a significant risk in 2016- since the global financial crisis in 2008, inflation in the United States has been consistently low. When Trump was elected president, the federal funds rate was still in the low range of 0.25-0.5%, reaching a peak of 2.25-2.5% during his term. By contrast, interest rates have already been above 4% since the beginning of Trump's term.
Therefore, Allen believes that by every indicator, the financial and economic situation is more severe than when Trump took office, inflation is higher, monetary policy is more restrictive, asset valuations are higher, and the debt situation is more difficult.
Key point ③: The risk of US debt ceiling crisis in the next two years will be greatly reduced
Of course, good news for the market is that if there is a Trump craze (Trump wins the election and the Republicans win both houses of Congress), the risk of a debt ceiling crisis in the next two years will be greatly reduced.
Allen stated that extending the debt ceiling would require legislative approval from Congress, but in a unified government controlled by a single political party, this would become much easier. In addition, considering that default may trigger financial crises and economic downturns, there is also a strong political motivation to avoid default.
In recent years, it is no coincidence that the debt ceiling crisis in the United States (such as 2011 or 2023) has all occurred in the context of the split government. But if people really see the Republican Party winning a big victory, then the debt ceiling will not be the main political issue that will arise in the coming years.
Key point 4: Political instability in the United States is becoming the new normal
Allen pointed out that the US political situation has been very unstable in recent years: in 9 out of the past 10 presidential/midterm elections, there has been a change of control in at least one of the White House/Senate/House. Therefore, the speed of change in the political landscape may be faster than many people expect.
In the past 20 years, there have been significant changes in the political situation in the United States. In 2004, George W. Bush won his second term, and the Republican Party controlled the presidency and both houses of Congress. But in 2006, the Democratic Party regained control of both houses of Congress, and in 2008, under Obama's leadership, regained the presidency once again. Subsequently, the Republican Party regained control of the House of Representatives in 2010, the Senate in 2014, and the White House again during the Trump administration in 2016-12 years later, the Republican Party once again achieved a complete victory. But then the Democratic Party won the House of Representatives in 2018 and regained the presidency in 2020. After the results of the Georgia Senate runoff were announced, they regained the Senate. In 2022, the Republican Party regained control of the House of Representatives, and in 2024, they regained control of the White House and Senate (as of the time of writing this article, the House election is still a few votes away from the Republican Party's victory).
Allen said that fundamentally, the key is the increasing political turmoil in recent years, and 2024 is a bad time for current presidents around the world. Although the current changes in the political landscape may seem drastic, the situation may rapidly fluctuate back and forth.
Allen pointed out that these increasingly frequent political changes are in stark contrast to the decades after World War II, when the party composition of the US President/Senate/House of Representatives typically remained unchanged for 4 to 8 years.