Asset Management: Monthly Macro Insights - December 2024

While global growth has proved resilient to policy tightening, significant divergences have emerged across countries, and the outcome of the US election has increased the risks for that trend to amplify. Furthermore, by choosing not to act on any assumptions about what the incoming US administration might enact, combined with the long and variable lags of monetary policy, the Fed will struggle to contain the economic consequences of Donald Trump’s priorities.

Regional divergence to widen further

The US experienced the fastest GDP growth of all G7 countries in the past two years, and this exceptionalism has generally been positive for growth elsewhere, as US demand boosted global trade flows and asset prices. Amid promises of loose fiscal policy and stimulated by businesses’ animal spirits, the US economy should stay robust in the short term. However, the initial positive effects could fizzle out and possibly reverse, and the hit to business sentiment outside the US from the threat of a widening trade war may be the most important channel of transmission.

US inflation risk on the rise

If the new Administration decides to abruptly implement some of its policies –such as those related to tariffs or deportations – the Fed’s response would most likely occur too late to fully mitigate the economic impact. In that regard, higher import prices, as well as labour shortages caused by a much stricter immigration policy, would raise inflation and push up inflation expectations that have already reached levels rarely seen in the past few decades. In turn, this would increase uncertainty and necessitate more aggressive monetary adjustments, hence leading to higher interest rates, especially if the fiscal outlook worsens.

Fragile US fiscal outlook

Public debt levels are elevated around the world, and the US is no exception. Its debt is at record levels and the long-term trajectory is unsustainable, although a precise tipping point is unknown. Some investors seem confident that the deficit could be reduced by slashing spending, especially since Tesla’s CEO Elon Musk has been appointed as co-head of the new Department of Government Efficiency, and suggested it would be possible to drastically cut spending by eradicating waste. Yet, only 30 per cent of the federal budget could realistically experience significant spending cuts, and it still includes agencies such as transport, education, agriculture and Homeland Security, which deliver important government functions, especially as the US already spends a considerably smaller share than other advanced economies. If Trump enacted all the measures he has suggested, one may question how many years it will take for investors to question the risk-free status of US Treasuries, thus markedly increasing US bond market volatility.