Market commentary bonds: Will everything change under Donald Trump?

US election result

The US election was the dominant theme on the capital markets in the last quarter of 2024. Donald Trump not only won the majority of electoral votes including all swing states and the majority of all votes, but can also govern without compromising Congress as the Republicans won the majority in the Senate and House of Representatives.

Trump’s programme – and how much of it will actually be implemented after the election and in what way – is the subject of much debate. Will there be tax cuts for companies and private individuals to boost competitiveness and consumption? How will a further increase in the budget deficit, which has already exploded during Trump’s first term and under Biden, be prevented? How successful will Elon Musk’s efforts to curb excessive government spending in various agencies be? And what impact will these measures have on inflation rates?

Will the US economy actually flourish by strengthening competitiveness, be it by facilitating and subsidising investments, lifting regulation (oil drilling) or restricting competition (tariffs)? And will a pro-innovation policy (e.g. crypto) further extend the US lead in the technology sector?

And finally, will Donald Trump succeed in stopping the flight from the dollar that has been triggered by sanctions and confiscations, or will we see another trade war with China? What geopolitical initiatives will the Trump government launch? And how will it deal with the issue of immigration?

Market reaction

The markets reacted very clearly to the election result. While US interest rates initially rose but then stabilised relatively quickly, interest rates in Europe went into reverse.

As can be seen from the chart, US yields fluctuated after the election before falling moderately at the end of November and climbing again in December. In contrast, German interest rates fell significantly by 40 basis points after the election result, and even the general rise in interest rates in December was unable to bring interest rates back to their original level.

European investors fear that a more protectionist US trade policy could dampen the sales prospects of European companies in the US and trigger further downward pressure on the economy in Europe. This is likely to prompt the ECB to cut interest rates more than previously expected. Accordingly, market participants see the ECB’s key interest rate at below 2 % at the end of 2025.

In the USA, on the other hand, uncertainty has increased regarding the future course of interest rates. Will more protectionist trade measures and a shortage of labour due to immigration restrictions lead to inflation? Or will inflation rates remain low and the new US government’s room for manoeuvre high?

The US central bank cut interest rates by 25 basis points in December, but is more cautious about the future interest rate path. The Fed’s published dot plots show this:

As can be seen, the Fed members’ assessment of the future interest rate path has changed significantly from the September survey to the December survey. For 2025 and 2026, two fewer interest rate hikes are now expected than a quarter ago. This shows the greater uncertainty that the Fed is facing. It is also interesting to note that interest rate expectations for 2027 have risen quarter by quarter. These reflect the ongoing debate as to whether higher interest rates than in the past are needed in the longer term in order to maintain a neutral monetary policy.

Credit spreads also reacted very clearly to the election outcome. While spreads in US IG and HY credit rallied strongly, Europe saw spreads widen. The European markets only joined the US trend with the favourable market environment in December.

As the chart shows, the US markets reacted euphorically. IG spreads fell by 9 basis points to 74 basis points despite the low starting level of 83 basis points. US HY spreads even fell by more than 20 basis points. In Europe, on the other hand, IG spreads rose by 9 basis points to 1.08 %. On the one hand, this difference reflects the euphoria in the US about the expected targeted economic stimulus policy, and on the other hand the fear in Europe of being caught in the crosshairs of protectionist measures and being further left behind by the US in terms of economic growth.

What can we expect for 2025?

The decisive factor for the further development of the markets will be which policy the new government chooses and what impact this has on growth and inflation:

• Inflation would be driven upwards if the budget deficit were to increase further as a result of tax cuts without corresponding spending cuts. Similarly, a radical deportation policy would presumably exert pressure on the labour market and push up wages. If the government is also successful in its attempt to boost economic growth, inflationary pressure could increase. In this case, the Fed is likely to cancel plans for further interest rate cuts and, in extreme cases, even move back in the direction of interest rate hikes.
• In a positive scenario, the budget deficit decreases due to lower tax cuts, higher growth or cuts in government spending. Policy is not too aggressive in terms of risk factors for the labour market and trade relations, and growth is positive without causing the economy to overheat. Combined with moderate inflation rates, this could prompt the Fed to cut interest rates further and provide monetary support for the economy.

In the first scenario, we are likely to see rising interest rates and supported spreads. However, the latter would come under pressure if monetary policy becomes more restrictive. The second scenario offers credit investors optimal conditions and should ensure that 2025 will be a strong credit year for the third year in a row. The first few weeks of the new government should quickly show which way the pendulum will swing. We are in for another exciting quarter.