Trump 2.0, here we go

This note contains an overview of our market views, what we are watching, and our portfolio strategy. Any reference to portfolio positioning relates to our Flagship Solution. Clients with bespoke discretionary or advisory portfolios should consult their Client Advisor for the latest update on your portfolio.

In this weekly market update, we’re continuing to answer some questions we’ve received following the release of our 2025 Market Outlook.

Question #1: Trump has indicated that he will increase tariffs on goods that the US imports. What impact could these tariffs have, and should we be worried about it?

Tariffs could be enacted as soon as today, with Donald Trump expected to sign executive orders after taking office. We think tariffs are likely to be a negotiating tool rather than a goal. After all, Trump’s negotiation strategies, outlined in his book The Art of the Deal, emphasise boldness, preparation, leverage, publicity and persistence. Moreover, with a more pro-business team than in Trump’s first term, the policy tone may be more balanced, although still driven by “America First”.

Raising tariffs too quickly risks stalling growth with rising prices, countering Trump’s goals to boost growth and control inflation. The inflationary impact will depend on tariff size and scope. High US reliance on imports suggests tariffs may be inflationary. The effect could be offset if domestic industries absorb the costs. However, it’s worth noting that a strong US dollar reduces import expenses.

While tariffs may have a neutral impact on the US economy, they could strain relations with affected countries like China, Mexico, Canada and Europe, and are likely to be negative for these economies. Due to the risk of tariff rises, we don’t hold any tactical positions in European or emerging market equities. We’ve also adjusted the protection against equity drawdowns in Europe, so as to increase the reactivity to the potential negative events the European equity market faces over the short term.

Question #2: The US dollar has appreciated versus other major currencies due to the relative strength of the US economy. Will this trend continue?

The US dollar performed well in late 2024 relative to the euro and pound sterling, thanks to the strong US economy and expectations of Trump’s election win. Markets believe his policies will boost growth, especially compared to the weaker eurozone and UK. This has driven demand for the dollar, with many positive developments already factored in, while negative news is priced into the euro and pound sterling. As a result, a stronger dollar versus these other currencies has been a popular trade.

However, while dollar strength in the near term is our base case, the risk is that this might not last throughout 2025. We think the dollar is currently overvalued and overbought, and Trump may face challenges in fully delivering on his growth and inflation promises. Even with scaled-back policies, a larger fiscal deficit is likely, which could weaken the dollar at longer horizons. If Trump fully implements his agenda, it might put even more downside pressure on the US currency.

Meanwhile, Europe’s situation could surprise us. With expectations already low, there is room for better-than-expected outcomes. The eurozone economies are especially competitive against the strong US dollar, and the euro is near its 2022 lows despite no energy crisis. The political uncertainty in Europe may also ease. In Germany, a grand coalition could slightly relax strict fiscal rules. France’s situation is less clear, but fiscal consolidation could be delayed, supporting growth.

In short, the US dollar may stay strong in the short term but give back some value as 2025 progresses. At the same time, the euro might gain from improving conditions and reduced uncertainty. This sets the stage for a shift in currency dynamics (with the pound sterling moving more sideways at this stage). But the balance of risks remains in favour of a strong US dollar.

Question #3: Europe seems to be caught in the tensions between the US and China, and there is no clear trajectory in the near term. Will Europe sort out its structural challenges?

European asset prices already reflect much of the doom and gloom. We recently reduced exposure to eurozone stocks and high-quality bonds due to geopolitical risks and weaker growth prospects. Instead, anticipating European Central Bank (ECB) rate cuts, we shifted to safer short-term government bonds, with a preference for short-dated ones.

That said, while manufacturing remains weak, services activity hints at a recovery. We could see fewer fiscal constraints, too, when monetary policy becomes less restrictive, meaning the rise in bank lending could continue. Falling inflation also helps real wages and could boost household savings, supporting economic activity.

Looking ahead, the eurozone may address some of its structural challenges using recommendations from Mario Draghi’s 2024 report, The Future of European Competitiveness. Key proposals include increasing investment, aligning industrial policies, creating a shared budget and supporting joint borrowing. The report also advocates reducing bureaucracy and enhancing trade policies, such as prioritising trade agreements with resource-rich nations to strengthen economic security.

Watching economic activity data this week

This week, markets will continue watching earnings for the last quarter of 2024 (Netflix on Tuesday, Procter & Gamble and Johnson & Johnson on Wednesday). The season started on a firm footing with financials such as JP Morgan and Bank of America. The focus shifts to Friday’s preliminary January purchasing managers’ indices (PMIs), likely showing stronger US corporate activity compared to Europe and China and continued strength in services over manufacturing on both sides of the Atlantic. In Europe, consumer sentiment data will be key – Thursday for the eurozone and Friday for the UK. The UK also releases its labour market report on Tuesday.

Japan’s January PMIs are also due Friday, but the spotlight is on the Bank of Japan meeting. Markets expect a quarter-percent rate hike to 0.5%, as inflation holds steady at around 3%, exceeding the 2% target since April 2022.

Attention will then shift to next week's major central bank meetings: the Fed, ECB, and Bank of England.