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Global Macro – EM EMEA prospects post US elections
The outlook for EM in 2025 is challenging, shaped by heightened tariff risks, elevated US interest rates, and a strong US dollar. Larger EMs, such as the BRICS, are expected to slow due to policy tightening, while smaller EMs rebound after macroeconomic adjustments. Inflation is easing but remains elevated in some regions, and monetary easing will broaden, though constrained by external pressures. Trade tensions under “America First” policies and a strong dollar will weight on EM currencies and capital flows, with financial markets facing tight credit spreads and limited room for further gains. Moderate equity returns are anticipated, driven by earnings growth, with outperformance expected in regions like China, ASEAN, and GCC. Success for EMs will hinge on strengthening domestic fundamentals, implementing sound policies, and adapting to volatile global conditions.
US Fixed Income: Exploring Impact of Immigration
Macro View: US labour statistics have provided mixed messaging on the true health of the jobs market for some time now. However, the recent December 2024 jobs report exhibited broad based strength that we haven’t seen in quite some time. The headline monthly reading from the establishment survey was a decent beat at 256K (vs 165K consensus). Notably, the unemployment rate ticked down to 4.1% due to a strong 478K gain in household employment, which outpaced the 243K gain in the labor force. Job gains were concentrated in services sectors like retail and leisure/hospitality, whereas there was a contraction in goods-producing employment, led by manufacturing.
Meanwhile, there has actually been continued progress on core inflation readings. The December headline and core CPI readings came in at a 0.4% and 0.2% month-over-month pace, respectively, while the supercore measure of inflation slowed to 0.2%. Housing inflation, the stickiest element of core, saw owner’s equivalent rent (OER) up 0.3%. While gas and used vehicle prices were strong; core goods prices were subdued, hinting that wholesalers haven’t yet forced through price increases ahead of tariffs. Producer prices (PPI) also surprised to the downside, contributing to expectations for a softer core PCE (which the Fed should care about more than CPI).
Fed view: In the context of a stronger than expected December jobs report and hawkish-leaning Fed commentary, we now expect a longer pause and have reduced the total amount of easing in 2025 to just 50 bps, with cuts in June and September. We also expect QT to continue on longer, with updates on the QT process taking place in early summer. Not only was the December Fed cut a “close call”, but the Fed minutes from that meeting indicated that many Fed member participants saw the need for a careful approach in the coming quarters, expecting to slow the pace of rate cuts ahead.
Almost all members saw increased upside risks to the inflation outlook, and some policy makers expressed worry that progress on inflation may slow depending on how Trump’s trade and immigration plans are implemented. As for Fedspeak, Bowman said that she could have supported taking no action at the December meeting and indicated policy may not be as restrictive as others may think. Schmid noted the strength of the economy will allow the Fed to be patient on rate adjustments, and Harker said the Fed should be able to stay where they are for a little bit, but not long.
Trump 2.0 view: As for politics, the incoming Trump administration will need to balance several priorities: tariffs, fiscal sustainability vs tax policy, deregulation, and economic growth. Of course, there is a risk that Trump 2.0 throws caution to the fiscal winds and does not course correct the ever-growing government spending and large deficits.
Meanwhile, in our view a lot of good news on growth is already priced-in to markets, while bad news (tariffs etc) isn’t. In his first week back in the oval office, President Trump signed into law a slew of executive orders, as well as rescinded over 70 Biden-era policies as well. While President Trump did discuss tariffs (floating the idea of 25% on Canadian and Mexican imports and a further 10% on China), so far no tariffs have been implemented. However, he did order federal agencies to study the impact of trade policies and have the Treasury and Commerce departments advise on creating an “External Revenue Service” for collecting customs and duties tied to trade.
Meanwhile, Trump launched efforts to secure the border, put a freeze on federal hiring for certain non-military/defence/immigration enforcement jobs, and withdrew from the Paris Climate Agreement. In general, the Trump administration has turned the nation’s focus away from renewable energy and has actually declared a national energy emergency in order to focus on expanding oil and natural gas production.
Market Implications: The common feature of the broader markets is for participants to latch onto a narrative and/or hedge for a certain outcome so that when the event and results are realized, a lot of the logical movements are usually priced-in. We argue that given how well televised much of Trump policy objectives have been into and out of the election, we have yet to see new headlines move markets much in either direction. Furthermore, long-term US rates have been discounting concerns over higher inflation (from import costs rising due to tariffs and/or less immigration) as well as supply concerns (via fiscal largesse) that it’s not surprising to see rates trading in a range now
FX Outlook
The US dollar surged by nearly 8% in Q4 in anticipation of the incoming administration implementing policies that would increase inflation risks and hence lift yields and strengthen the dollar. On a year-to-date basis the US dollar is weaker with the conviction of the view that fuelled the Q4 move diminishing with President Trump yet to implement any trade tariffs. However, threats have been made and we believe over the coming weeks President Trump will follow through and implement tariffs on imports from Mexico, Canada and China. That will prompt a rebound in the US dollar reinforced by a more cautious Federal Reserve. The BoJ lifted its key policy rate last week and that should help to curtail dollar buying against the yen. .
USD/JPY - Bearish Bias - 148.00-160.00
EUR/USD - Bearish Bias- 1.0100-1.0800
USD/CNY - Bullish Bias- 7.1500–7.3500
KEY RISK FACTORS IN THE MONTH AHEAD
- Given the price action in the financial markets today, there are increasing risks of increased volatility and the potential for a larger move to the downside for USD/JPY. US exceptionalism is very much in the price of the US dollar and a tech-related sell-off if sustained could see much larger than expected US dollar depreciation. The flip side is that Trump becomes aggressive with his trade tariff policies and the Chinese authorities allow for a larger than expected depreciation of CNY that fuels renewed USD/JPY buying.
- The main upside risks for EUR/USD include: i) the Fed signalling that it is planning to cut rates again sooner in March, ii) President Trump refraining from implementing tariff hikes in Q1, and iii) a deeper correction lower for US tech stocks weighing on the USD.
- The main upside risk for USD/CNY remains on Trump’s tariffs on imports from China. And before more incremental policies are implemented, the current housing price cycle may still be in the process of bottoming out, economic growth and price trends still need to improve, and interest rate trends largely depend on the strength and effectiveness of countercyclical policies. The decline in market interest rate could be another upside risk for the pair. Downside risks for USD/CNY include the stronger than expected fiscal support in China.
European Credit
In January 2025has seen the EUR credit markets rally with the aggregate Corporate index tightening around 9bp on z-spread. We are now back at levels seen last in January 2022 but still off the multiyear tights seen in June 2021 of z+82bp.
The overall EUR corporate IG index stands now at z94bp, down from z146bp in early January 2024. Overall credit yields have gone up from just below 3% in mid December 2024, to around 3.33%, but still down from last year highs of 4.15% in mid-June.
The oil prices have been somewhat more volatile in the last month and went up to USD80 per barrel but have declined to USD74 since the mid January peak and are now in the middle of a 12 month range. Other risk indicators such as Bund-BTP spread have now tightened to 111bp, from the June 24 wide of 158bp, and is now close to the 3 year tights of 107bp seen in October 24.
The election of Trump to the US presidency has increased USD rates uncertainty and divergence between US and European. Trump’s agenda is seen as inflationary and, taking into account Europe’s relatively stagnant economy, as demonstrated by the German second successive year of slightly negative economic growth. Nevertheless European credit continues to benefit from the market’s assumption that a soft landing remains the most likely outcome.
German elections in February are a next key catalyst in Europe, against the backdrop of a more aggressive policy stance on international trade by the new US administration.
The Itraxx Main is back at c.55bp, after having touched 59bp in January, remains close to its two year tight of 50.5bp
We move to a neutral stance on European Banks spreads and we retain a cautious stance towards European IG corporate credit, on rich valuations, with a preference for defensive sectors and higher quality credits over cyclicals and higher beta credits.