Charts of the Month

CHART 1 – DIGESTING DEBT

Recent editions of Charts of the Month have been dominated by the US and specifically “Trumpmania,” but for good reason.

The Donald’s return as Commander-in-Chief will have a major bearing on the global economy and markets this year. Especially when it comes to fiscal policy.

For all the talk of budget cuts and a return to fiscal discipline, it’s important to highlight how government spending has been the main driver of GDP in recent years.

Take this away and the economy (and markets) would likely take a major hit, meaning tax cuts and large deficits should ultimately prevail.

However, that will heighten concerns surrounding the surging costs of servicing the sovereign debts.

The chart below shows the US net government interest payments as a percentage of GDP.

A combination of rising debt issuance and higher borrowing costs has seen this ratio almost double, to 4.5% of GDP, in just 3 years.

It reflects the fact the US Treasury now spends over U$1trn a year just on interest payments, which means the Trump administration has little margin for error when it comes to economic policy. At least as far as the bond market is concerned.

CHART 2 – ANIMAL SPIRITS ARE BACK

Something appears to be stirring in the US economy.

We mentioned last month how corporate “animal spirits” have been rekindled since the election with businesses espousing a more constructive tone on hiring and investment plans.

This is now being confirmed by recent data points.

The chart below shows the monthly survey of manufacturing activity in Philadelphia (blue line) compared to the nationwide Manufacturing ISM (red line).

There tends to be tight relationship between the two, so January’s surge in the regional index suggests firms across the country are embarking upon a more expansionary phase.

If the red line follows suit over the next few months, it will add weight to the prospect of a sharp increase in US GDP growth this year.

CHART 3 – GOLDILOCKS GOOD. BOOM BAD?

At face value, anything that reduces the risk of a US recession should spell good news for the stock market and other risk assets.

However, the potential for a spike in bonds yields rises as the growth outlook improves. And, as we saw in 2021/22, that tends to be a headwind for equity investors.

There are two potential catalysts for much higher US bond yields.

The first is a continuation of fiscal largesse as this would prompt the bond vigilantes to come out in force against the government’s excessive debt use.

The second would be a resurfacing of inflationary pressures. This time likely borne of a strong economy and demand surge, rather than supply bottlenecks.

The chart below shows the close link between market-based inflation expectations (red line) and the 10yr Treasury yield (blue line).

For now, inflation expectations remain anchored, but the risks are skewed to the upside and we could well see the 10yr yield trade comfortably above 5% this year.

However, any spike should be short-lived. The US government needs low rates to help it refinance around U$10trn of borrowing this year so any disorder in fixed income markets is likely to be met with yet another QE-style program.

CHART 4 – DOLLAR DOWN, ALL ELSE UP (USUALLY)

In an uncertain world, one thing is abundantly clear…President Trump wants the US dollar to weaken. And he is likely to use that as a bargaining chip in trade negotiations with China.

Assuming he gets his way, and the greenback does retrace some of its recent gains, the stage will be set for big gains in emerging market stocks.

The chart below shows the DXY trade-weighted dollar (blue line) versus the Emerging Markets equity index (red line) going back to 1988.

The dollar has experienced three meaningful downtrends over that period; the early 1990s, the early 2000s and 2017-2021.

It’s relevant that the last episode coincided with Trump’s first term.
On each occasion, emerging market equities staged big bull markets and they would likely do so again if the dollar weakens from here.
It also plays into the idea that a weaker dollar could form part of a US/China reconciliation.

Chinese equities make up around a quarter of the Emerging Markets index and are primed to rally strongly in a scenario that sees trade tensions ease, particularly if the authorities amplify their efforts to stimulate the domestic economy.