On shaky ground
184 Monday, 26 May 2025 15:46
Divergent Opinions in External Articles - The opinions expressed in articles from external sources do not necessarily reflect the views of Renalco SA and are shared for informational purposes only.
Half-way through Trump’s 90-day grace period for reciprocal tariffs, trade negotiations appear to be stalling, and markets are getting nervous, again. Trump is losing patience and threatened to impose a 50% tariff on EU goods at the end of last week. The question is whether he really intends to lift the EU tariff or whether he is just adding pressure to accelerate negotiations. At this stage, the latter still appears to be the most likely scenario. With mid-term elections taking place in less than 18 months in the US, Trump’s window for making disruptive moves will soon close. He will put his majority in Congress at risk if he causes a recession or a financial blow-up.
Meanwhile, the “big, beautiful” tax bill is about to be voted upon by Congress and US bond markets are in search of a new equilibrium. Preliminary assessments suggest it will significantly add to budget deficits and to public debt over the coming years. Although it can still be marginally altered by the Senate, the Congressional Budget Office (CBO) estimates that, over the next decade, it would add USD2.3trn to existing deficits and USD3.1trn to public debt (USD200-300bn per year, +1pp of 2025 nominal GDP).
- Towards a Liz Truss moment in the US? Long-term Treasury yields have been on the rise, reflecting some concerns about fiscal sustainability over the long run. Although 10-year yields remain in the middle of the range of the past two years at 4.5%, 30-year yields now stand above 5%, close to levels unseen since the mid-00s. Swap spreads have turned deeply negative, illustrating the sovereign premium. Also, renewed dollar depreciation vs. euro, despite the widening interest rate differential, reflects a higher credit risk premium being attached to the sovereign. Market concerns are somewhat overdone in our view, but we must admit that this US administration can bring a lot of nasty surprises.
- Why you should not be excessively concerned. The CBO does not factor in additional budget revenues related to trade tariffs, which are estimated to be in the range of USD200-300bn per year. The fiscal bill would then be more neutral for public finances than the CBO estimates suggest. But the fact is that the bill does not address fiscal slippage, and one cannot rule out some spending cuts being removed by the Senate.
European fixed income markets have experienced some contagion effects from the US, pushing bond yields in euros higher as well. We see this as an opportunity for euro area investors, since it is unrelated to fundamentals in the region. Yet, financial markets are integrated. If bond yields keep rising in the US, which is not our central scenario, yields in the euro area will also be pushed higher.
- We estimate there is a 0.5 beta between US dollar and euro rates, i.e. a 100bp rise in 10-year Treasury yields has historically translated into a 50bp rise in 10-year Bund yields.
- Lower growth prospects in the euro area as well as a more sustainable public debt path when looking at the eurozone as a whole suggest that European rates are appealing at such levels.
Towards a dollar rebound ahead? Our interactions with clients and CFTC data on investors’ positioning suggest it is very consensual to expect a weak dollar. Interest rate differentials should be supportive for the US dollar, since the Fed has maintained the status quo while other major central banks (except the BoJ) have remained in rate-cut mode this year.
We advise to keep hedging a significant chunk of dollar exposures for now. Currency fluctuations have been erratic, sentiment is negative, and we cannot rule out markets pushing the dollar down further in the near term as the end of the 90-day grace period approaches. We have in mind that over the course of 2017, when Trump cut taxes for corporates and households during his first mandate, the US dollar fell by 12% versus the euro, despite a widening interest rate differential that should have been supportive. Note, however, that the US dollar is already down 8.5% year-to-date versus the euro.
In the report, we revisit implied FX exposures from a cross-asset perspective. Based on recent market dynamics, US equities and Japanese equities are the most positively correlated to the DXY (based on daily returns over the past three months). Conversely, Gold has been the most negatively correlated asset to the DXY recently. A bullish view on the US dollar could then be implemented through long Japanese equities versus short Gold. Longer-term estimates show most asset classes are negatively correlated to the US dollar, suggesting that a weaker dollar should be a positive for global markets, both equities and bonds, and both EM and DM.
Amid the current trade war uncertainty, we upgraded Personal Care, Drug & Grocery Stores to OW in European equities. This is the most defensive sector, with a two-year beta of 0.45x. Looking at the sector’s composition, the sector is a 50/50 blend of Food & Drug Retailers (very domestically exposed stocks and sheltered from trade wars) and Household & Personal Care (HPC) stocks. The latter are admittedly global stocks, but their business models are based on a local-to-local approach, which limits the impact from tariffs. Lower oil prices (we expect Brent to fall towards USD50 in the coming months) should support the purchasing power of global consumers and also be a tailwind for HPC stocks’ margins, as many raw materials are oil derivatives. Finally, valuations look reasonable, with a forward P/E of 16x compared to 18x over the past 10 years.
Week ahead: Nvidia quarterly earnings, minutes of the 6-7 May FOMC meeting.
Copyright © 2024 Kepler Cheuvreux. All rights reserved.
This document is produced by Kepler Cheuvreux, an investment firm authorized by the ACPR under number 14441 and regulated by the Autorité des Marchés Financiers, incorporated in France under number RCS 413 064 841 at the following address: 112 Avenue Kleber, 75116 Paris, France (www.keplercheuvreux.com).
This document does not constitute a prospectus/regulatory document or other offering document, nor does it constitute an offer or solicitation to purchase securities or other investments. It should not be construed as an offer to sell or a proposal to buy any securities in any jurisdiction in which such an offer or proposal would be unlawful. We are not soliciting any action on the basis of this document, which is provided to our clients for general information purposes. It does not constitute an investment recommendation or a personalized recommendation, and does not take into account the investment objectives, financial situation and needs of each client. Before acting on the contents of this document, we advise you to check whether it is suitable for your particular situation and, if necessary, to seek professional advice.
The figures relating to past performances refer or relate to past periods and are not a reliable indicator of future results.
The accuracy, completeness or timeliness of information from external sources is not guaranteed, although it was obtained from sources reasonably believed to be reliable. Kepler Cheuvreux assumes no responsibility in this regard.
Information provided in this document concerning market data is retrieved from databases at a precise period of time and is subject to variations.
