Deutsche Bank has the right idea.
Trump is only 30% priced.
It is impossible to have a strong view on what will happen. What we prefer to assess is market pricing. We approach this question by generating a maximalist and minimalist scenario in terms of the policy mix. There are three key variables we focus on:
- net fiscal spending,
- tariffs,
- immigration.
On net fiscal spending, the maximalist scenario is at 1% of net fiscal expansion legislated by mid-June. On tariffs, it is a removal of China most favoured nation treatment (50%+ tariff), a 10% universal tariff from 2026, with threat of more and auto-specific tariffs.
On immigration it is a sharp slowing of migrant inflows within the first six months back to the Trump 1.0 run rate, bringing breakeven payroll growth down to 100,000.
Where would market pricing be under this scenario?
Fed pricing at 5% or above, ECB at 1% or below, making for a 400bps spread.
Under the business as usual / no impact scenario we would have the Fed – ECB gap back in line with the historical r* average of 100bps.
The market is currently roughly priced at a 200bps gap, or a 1/3 probability of the maximalist view.
The conclusion is remarkably identical on multiple other metrics.
For example the “hump” in 1y1y US breakeven inflation is 15bps, we would see at least a 50bps impact of tariffs on headline CPI so this is again consistent with a 30% probability.
Similarly the dollar is only pricing a 3% safe-haven premium on our models compared to a 10% maximum during the first trade war.
The bottom line is the market is still not pricing a lot of Trump.
We remain bullish on the dollar and would view EUR/USD levels of 1.00 as pricing the intensity of the Trump policy mix at closer to 50%, with potential for even greater downside depending on what happens next year.
Germany at risk of secular stagnation.
Private investment is in its fourth year of decline; the private saving rate is at its highest since the early 1990s; demographics are turning sharply negative.
A reform of the debt break is a necessary, but in our view not sufficient condition to reverse this bad equilibrium.
Three things need to happen in our view: first, the centrist parties (ex FDP) need to get to 66% in the election to be able to amend the constitution.
At the moment the polls are saying this is too close to call.
Second, the fiscal stimulus needs to be more than military spending, which will effectively be a fiscal transfer to the US.
Third, it needs to be spent quickly, as hysteresis effects are kicking in.
Either way it will not be relevant for the ECB next year.
The German employment PMI is telling us the labour market is weakening, the IG Metall negotiations only gave a 1% wage increase for next year and Euro-area inflation should be below 2% through 2026.
At the same time, both the French and Italian fiscal stance is tightening. Chances of an EU-wide instrument? Very low, note that both the French and Dutch governments could be close to unravelling (again). The bottom line: market pricing of the ECB should be at 1.5% as a minimum.
China could have no option but to move the FX.
If tariffs go ahead, China could be impacted via three channels.
- The direct impact of US tariffs (this would be 8% on the terms of trade under removal of MFN),
- the indirect impact of countervailing tariffs (note the EU applied such duties on steel during Trump 1.0),
- the broader strength of the USD.
A move to 8.00 in USD/CNH with all other USD crosses unchanged would merely offset US tariffs and this doesn’t account for the likely broader USD move or other countervailing duties.
A reminder that in 2022, USDCNH moved by 15% that year. Don’t let the last two years’ narrow FX moves be an anchor to possible moves.
Finally, note that a new China bill to apply tariffs of as high as 100% was submitted to the US Senate just last week.
A bi-partisan congressional committee on China again recommended removal of normal trade relations with China. Watch to see if tariffs are legislated via the budget reconciliation process.
This would make them far more permanent.
Nothing moves all one way, especially in forex. The speculative long is growing in the USD.
But, equally, it is still long the AUD, largely on the basis that the RBA isn’t going to cut rates.
When that view is proven incorrect, AUD will fall like a stone with EUR and CNY.
AUD 50s loom in 2025.
