Positive on EUR rates against a backdrop of additional economic headwinds

This US presidential cycle was historic in many ways, not least in terms of the starkly contrasting policy agendas proposed by the opposing candidates. Combined with pre-election expectations of a tight contest – which turned out to be false – we already saw so-called “Trump Trades” gain and fall in popularity commensurate to his polling numbers. His vision of “America First” – tariffs, deregulation, restrictions on immigration and tax cuts – point to higher inflation, higher corporate profits, higher interest rates and probably higher growth as well.

In the end, the Republican victory was decisive. Donald Trump’s win and a Republican win in the Senate was certain by the morning after Election Day, and a win in the House of Representatives seemed likely. Markets quickly reacted exactly as one might have anticipated: risky assets rallied, and among them those with a domestic US focus – small cap equities and high yield bonds – were the biggest outperformers. Treasuries sold off and the yield curve bear-steepened, reflecting investor concerns about fiscal indiscipline.

Rates markets in much of the developed world reacted in nearly the opposite fashion. If the new administration implements its sweeping tariff agenda, there will be a clear negative impact on growth. European rates fell and the curve bull-steepened – reflecting expectations about a possibly accelerated trajectory in the ECB’s cutting cycle.

US rates: Underweight on almost-certainly inflationary Trump policy proposals

In the immediate run-up to the election, we had already moved from our previous small overweight on Treasuries to a neutral position, preferring not to take a position on what was, in our view, a difficult-to-predict and binary outcome.

We see Trump’s policy proposals as inflationary across the board. Tariffs will raise prices on goods and strong immigration restrictions will raise prices on services. Taken together, this may lead to an un-anchoring of expectations and attendant re-pricing of terminal rate expectations.

The effect on growth could be more nuanced, but more likely positive on balance. By themselves, tariffs will be a drag on growth, reducing consumer expenditure, but could be offset by fiscal stimulus. Indeed, we expect fiscal stimulus would be necessary to avoid a material negative growth impact from tariffs, which Mr Trump will probably be very keen to avoid.

The inflationary nature of Trump’s policy aims lead us to take a more prudent stance on US rates, while maintaining our bias for further curve steepening.

That said, we also expect a considerable degree of unpredictability in Trump’s governance. Ultimately, he may not go as far as promised and deficit spending could be reined in by Congressional Republicans, whose first instincts tend to be more hawkish on fiscal policy than those of the President-elect himself. The lack of certainty around the detail of Trump’s policies could put a ceiling on any excessive yield rises in the near term. We will continue to monitor policy developments and market reactions closely, and adjust our views accordingly.

Positive on EUR rates against a backdrop of additional economic headwinds.

We saw somewhat stronger economic prints coming from the eurozone over the month of October, with growth numbers better than anticipated and a slight rebound in PMIs. However, on a forward-looking basis, we see that manufacturing is still in recession territory and the incoming Trump administration is by no means a positive for European growth. Indeed, we may see a growth impact of 0.8%, which would push the eurozone from anaemic growth into recession. In the near term, there is probably also limited capacity for more fiscal stimulus – except in Germany, which appears to lack the political will. New elections are not until next year and the extent to which a new government will be willing to adjust policy remains unclear.

The inflation cycle seems to be trending below 2% in 2025 and we expect to see more deceleration in core inflation. Weaker growth via US tariffs would be a supplementary deflationary pressure. As we don’t see terminal rate pricing as excessively aggressive, we are comfortable keeping our overweight on EUR rates.

On the UK, we fundamentally remain convinced that the UK economy would have difficulty supporting the terminal rates as currently priced by the market, like the eurozone, as both are faced with similar structural weakness and low growth. However, we acknowledge that so far, the market has not come around to this view, and indeed post-election, we observed gilts trading directionally similar to euro rates – i.e. rallying even as Treasury yields rose – but not to the same extent. The Bank of England has also published new growth forecasts, which see growth increasing by 0.75% and also see inflation returning to target approximately a year later than previously. The budget unveiled by the new Labour Chancellor Rachel Reeves in October could also make the Bank of England’s task more difficult. The government foresees tax hikes, but extra spending is not fully funded and in net terms, the budget delivers significant fiscal loosening. We therefore now see a slowdown in the pace of BoE cuts compared to our previous expectation and temper the level of our conviction.

US credit: Valuations are still rich, but investor risk appetite seems unbroken

In line with other risk assets, credit spreads rallied further, especially in the domestically-focused high yield segment. While valuations remain at near-historically rich levels, given the clear appetite investors are signalling on US risk assets, we prefer, for the time being, to revert to a neutral view on investment grade and reduce our underweight on HY.

We also retain our neutral view on EUR investment grade credit. Spreads have indeed continued to tighten further by some 10 basis points over October, but unlike US credit, not quite to near historical lows. It is interesting to note that the swap spread of EUR IG credit remained flat, as indeed the swap spread of German government bond yields has turned significantly less negative at short tenors and is now positive at the 10Y. Fundamentals remain healthy and in the near term, although the growth outlook has certainly not improved, we don’t see foreseeable risks that would warrant a substantial correction. EUR HY followed a similar trajectory, with spreads narrowing by some 25 basis points. This is undoubtedly tight, but again, given OK fundamentals and the overall quality level of the asset class, we retain a neutral position.

Still positive on the US dollar

As noted, the trajectory for BoE rate cuts going forward could be a little more muted. We therefore prefer to cut our short vs. EUR following sterling’s weakness over Sept-Oct and take profit on this position.

In other developed market currencies, we continue to hold a long USD vs. EUR and a long on JPY. Structurally, we think that Trump’s policies should continue to benefit the dollar. We also like JPY. Global yields trending lower whilst Japanese monetary policy follows a divergent path should be beneficial, as the EUR itself becomes a viable funding currency for carry trades.

Emerging markets: On balance, we don’t see a significant negative impact from the election result

Following the US elections, we expect inflationary pressures to stem from incoming President Trump's willingness to implement tariffs as well as a likely expansionary fiscal policy.

In this respect, the strength of the dollar, which reduces the room for manoeuvre of other central banks, as well as a more direct impact arising from tariffs, all things being equal, will have a negative impact on the refinancing capacities of emerging countries that issue in dollars. On the other hand, this US economic policy could prompt China to step up its stimulus policy, thereby supporting other emerging economies at the same time.

Taking Mexico as an example of an ex-China country with high US exposure, what measures will be taken against Mexican imports and what effects they will have remains uncertain, and indeed the Mexican economy performed well during the first Trump administration. The fact that Mexican spreads hardly reacted at all to the announcement of the election results suggests to us that the markets had already priced in the possible effects of a change of administration on Mexico’s growth prospects. In hard currency sovereigns, valuations are still very rich compared to Treasuries, especially outside the riskiest debt. The picture is more nuanced compared to other risk assets. EM local currency rates, on the other hand, cheapened significantly in the run-up to the election, offering a better entry point – however, as noted, the scope for policy rate cuts is now also narrower.

In summary, for hard currency, we see rich valuations, OK fundamentals (slightly better for corporates than sovereigns) and strong risk appetite. For local currency, we see good valuations, but a less positive monetary policy outlook. As such, we retain a neutral view on both segments.

Chinese yields have trended lower and lower throughout the year, with the 10Y now trading around 2%. The relative lack of reaction to the recent announcements of a stimulus plan reflects that markets expect their impact to quite possibly underwhelm, but we expect to see a real impact – perhaps also with the new US administration conveying a greater sense of urgency to the Chinese government to act. As such, we see the balance of risks tilted towards yields picking up again from their current very low levels.

In emerging market FX, we initiate a long BRL vs EUR. Positive real rates in Brazil are becoming increasingly attractive, with the central bank hiking interest rates again to anchor inflation expectations.