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These are troubling times for Europe. Having apparently learnt nothing from Hillary Clinton’s campaign gaffe when she referred to Trump supporters as “deplorables”, EC President Jean-Claude Juncker has got off to a bad start with the man who will soon be the most powerful in the world by suggesting that two years of Trump’s presidency will be wasted while he gets to grips with basic world geography. Europeans, he said, would have to teach the President-elect “what Europe is and how it works”. While geography may not be Trump’s strongest suit, by 20 January he will have had intensive training on many issues, including the difference between Brussels and Belgium.
Trump’s presidency will present challenges for Europe (particularly if Juncker does not learn to ‘take more water with it’). However, it will also bring benefits. Trump’s proposed policy of spending a trillion dollars on infrastructure, combined with the traditional Republican policy of tax cuts, will be substantially reflationary. Indeed, 10 year T bond yields have already risen 50 basis points since the election and this fact has not been lost on the forex markets. EUR/USD is down to 1.0735, 5% lower than last Wednesday morning, and a weaker euro is just what the eurozone requires. Indeed, there is every chance of more to come.
Trump believes that ultra-loose US monetary policy has run its course. He has even openly pondered the removal of Janet Yellen so that the Fed can change tack on interest rates. We can therefore expect the US to run relatively tight monetary policy (certainly compared to the eurozone) for the foreseeable future and a loose fiscal policy. Interest rate futures markets are now predicting a 94% chance of a hike in rates at the December Fed meeting – a near certainty. Historically, this combination has tended to lead to currency appreciation, so we should expect the decline in EUR/USD to continue, taking some of the pressure off Europe.
We may see something similar in the UK, as Theresa May has pointed out some of the problems associated with ultra-loose monetary policy – not least the pain caused to savers while speculators benefit. However, the eurozone seems not quite ready even for an end to QE, which is scheduled for March next year. Germany’s fears in relation to the potential inflationary spike from QE have not arisen. In fact, with negative interest rates and deflation widespread in the eurozone, some reflation is precisely the medicine that is required.
While we continue to be concerned about core inflation eventually rising in the UK as a result of the import price increases resulting from GBP weakness (see Marmite and the Toblerone travesty), we are seeing some commodity price falls in the eurozone. For example, the price of Polish onions is down over 60% as a result of a bumper harvest, oversupply from other EU nations and a continuation of the Russian ban on EU food imports to the end of 2017 in retaliation against the EU sanctions over Ukraine. The trade sanctions between the EU and Russia, and the slowdown in Chinese demand, continue to put significant pressure on EU agricultural and produce suppliers.
Quite apart from the ongoing flirtation with outright deflation, from a political perspective the eurozone is likely to need all the help it can get over the next year, as the entire European Project is facing something of an existential crisis. The Italian referendum on constitutional change threatens the Renzi government, while the Austrian presidential election on the same day, 4 December, stands a very good chance of returning gun-toting, extreme right-winger, Norbert Hofer. Then there is the French presidential election next April. If Marine Le Pen were elected, it would make the shocks of Brexit and the US election irreducibly trivial by comparison. This is not some long-shot probability: Le Pen is currently 7/4 with the bookmakers.
One area where the Trump administration will bring substantial change is in relations with Russia. This is an area that has great capacity to divide opinion. Some believe that Trump’s pragmatic attitude towards Russia’s claim on the Crimea is inexcusable and will inevitably lead to further incursions into vulnerable Baltic states. Others see the real enemy of Europe as Islamo-fascism and would welcome a co-ordinated response from Russia and the US in the Middle East.
In the face of such a crucially important aspect of foreign policy, with the capacity to go very right or very wrong, it is perhaps strange that markets have not reacted more strongly to what represents a clear change of policy towards Russia, with extremely divergent potential outcomes. We are either on the verge of a new Pax Americana, or at the end of the old one. The latter scarcely bears thinking about, and that is probably the best explanation of the markets’ reluctance to do so.
All views expressed here are the author’s own and are based on information available at the time of writing.
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