What does Trump 2.0 mean for markets?

Meet the new boss. Same as the old boss. And this should lead to “US Secular Exceptionalism.”

At last we have our answer: Donald Trump has won the election, the GOP has reclaimed the Senate, and while we await results for the House, it looks like it is trending toward a red sweep.

The early market reaction has been eye watering, and investors are running back the same Trump playbook from 2016: The reflation trade is back.

• Yields are blowing out with the curve steepening, and real rates driving nearly two-thirds of the widening.
• The US dollar is soaring.
• The VIX is crashing lower.
• Cyclicals are ripping, led by financials.
• US equities are outperforming the rest of the world.
• Small-caps over large-caps.
• Value over growth.

While it has been only hours of trading since he was declared the winner, it is just a redux of the Trump 1.0 playbook. But the obvious question is, how far can this trade run? It is a tug-of-war between rates and reflationary optimism. Too much, too fast, and we could see that equity optimism short-circuited.

But for now, it’s risk on.

• Uncertainty is fading.
• Sentiment is rebounding.
• Volatility is compressing.
• Macro is constructive.
• Policy expectations are pro-growth.
• The mindset is buy now, ask questions later.

Our take

Looking across markets Wednesday morning, there is the feeling of overwhelming déjà vu. Looking back on our missives from 2016, we could basically dust them off and hit resend, and you would never know they were written eight years ago.

Broadly speaking, the knee-jerk reaction isn’t at all surprising. But there are a few interesting quirks.

• Commodities are broadly lower, led by crude and gold.
• Put that together with breakevens remaining largely well behaved, and markets seem to be focusing more on the positive growth impulse as opposed to inflationary risks.
• Reflation without much of an inflationary impulse – perhaps, as markets are downplaying Trump’s tariff rhetoric. Or maybe it’s that the China story continues to be mired in the mud, with piecemeal policy announcements that have underwhelmed, along with the potential trade confrontations with Trump?

Policy implications aside, the sheer fact that the election is behind us is helping remove the broad overhang of uncertainty. Investors and business leaders can breathe a sigh of relief in simply having a result – a dynamic that should support sentiment for both markets and businesses.

But while markets are off to the races with the old Trump playbook – the question is how far and how long can this run?

• While the Republicans have reclaimed the Senate, we still don’t have an answer on the House, and likely won’t know the outcome for a few days. That said, the trends are certainly pointing toward a red sweep, and markets are acting accordingly, running with enthusiasm over deregulation and tax cuts.
• So, it all comes down to who wins the tug-of-war between higher rates and reflation optimism. It’s not the level of rates that matters, but rather the rate of change. Equities can handle higher rates for good reasons. But, if you get there too fast, then it becomes difficult for risk appetite to digest.
• Reflation optimism is clearly being fueled by deregulation, tax cuts, and deficit spending. While on the flip side, rates are a function of growth optimism, inflation concerns, and the elephant in the room: deficits. How that tug-of-war plays out has important implications for risk appetite. And should we continue to see rates selling off, particularly that the red sweep come to fruition, that may begin to bite on risk assets.

Also keep in mind – why rates are rising matters. Decomposing the most recent move off the lows back on 9/16/24 through 11/6/24, we find:

• Nominal yields up +84 basis points (bps).
• Real yields +56bps.
• Inflation expectations +28bps.
• Two-thirds of the move higher in nominal rates has been driven by real rates.
• And this tells us that growth expectations are being revised higher. 
• Better growth prospects with marginally higher inflation. That’s a good thing! And maybe that lets equities coexist with higher rates. 

Yes, there’s still a lot of uncertainty regarding what the Trump administration’s agenda will look like, so we’ll offer up some quick comments on relevant topics:

• Tax cuts: Expect Trump to make the individual income tax cuts permanent. We’ll see how the corporate cut goes.
• Tariffs: Are the threats simply a negotiation tactic? Trump has been deemed a “transactional president.” Will he use the threat of tariffs as a bargaining chip? Tariffs will take some time to implement. Cabinet members likely need to be in place, which means tariffs likely become a headline next summer. And, you can expect currency weakness from competitors to price in these expectations, offsetting some of the bite.
• Regulation: Trump will have broad and unilateral authority to act. Think banks. 
• Immigration: Expect to see a crackdown and sealing of the border. Rounding up and deporting illegal immigrants will be a logistical challenge and will face some legal hurdles. Deporting those convicted of crimes should be expected.
• Inflation: On paper, Trump policies are expansionary. Stunting immigration growth could adversely impact the supply of workers, which has helped to bring wage pressures down. The path of Fed cuts going forward could become more gradual as a result. Trump has said that he would allow Chair Powell to serve out his term.
• The deficit: This is where heads will explode. Sure, Trump’s policies will add to the deficit, but deficits don’t always translate to higher rates. “US Secular Exceptionalism” has its privileges. What does this mean?
  • Having strong relative growth, equity markets, and demographics.
  • Having a strong military and leading technologies.
  • Having a resilient political system.
  • All of this adds to investor confidence, which allows the US debt to grow without a sharp rise in funding costs: In a world that is geopolitically dangerous, the US is the safest and strongest country with the strongest economy and currency. For the deficit and debt/GDP worries to take hold, this needs to change. And we don’t see this happening anytime soon.

Stepping back from the political implications, we’re still left with a supportive macro backdrop:

• Growth remains resilient.
• Inflation continues to cool back to the 2% target.
• The Fed continues to recalibrate policy.
• Global central banks are in the midst of a synchronized easing cycle.
• Corporate earnings estimates continue to drift higher.
• The tailwinds for the US economy remain robust.

Bottom line

• Trump 2.0 should be characterized as Secular US Exceptionalism. And this has its privileges. Fade the deficit fears.
• Expect US growth to remain firm, which supports an overweight to US equities.
• Expect the US dollar to remain strong. Tariff threats will likely see those in the crosshairs move to weaken their currency in order to compensate.
• Rates should remain firm.
  • Rates have done much of the heavy lifting given the pre-election move and today’s move.
  • The trading range on the 10-year treasury has shifted, in our view, from 3.5%–4.25% to something closer to 4.0%–4.75%.
• Profits over politics. Removing the election uncertainty itself is a positive, from both a risk sentiment perspective and a business activity backdrop. Now add in tax cuts (or at least an extension of cuts) and deregulation. Underlying growth remains firm, although the labor market has been cooling. Corporate America was doing well to begin with, now additional tailwinds have been added. Top line growth has been easing, so we will see how this evolves. 

The risk: an overshoot in interest rates too high. Rates are the biggest near-term risk to the continued rally in equities. We’ll be keeping an eye on inflation expectations. But so far, they’ve been modestly well behaved with rates rising for good reasons.