Trump 2.1?
Encouragingly for the UK, Keir Starmer’s charm offensive seemed to work on the president, who said a US-UK trade deal is being worked on, “where the tariffs wouldn’t be necessary”. On Ukraine, the Prime Minister even managed to elicit the magic word “backstop”, though Trump was vague about its meaning. Cordial relations are welcome, but Emmanuel Macron’s experience earlier this week (warm words followed by a 25% EU tariff announcement) shows how quickly those can sour. Promise and delivery are very different things for Trump – as investors have become well aware.

After November’s election, US investors got excited about the prospects of Trump 2.0 and the potential sugar rush of tax cuts and deregulation. Those goodies have not been handed out yet; instead, Trump’s early days in office have been about tariff threats and taking a sledgehammer to the federal government. US stock valuations have fallen from their extended levels, showing that investors’ confidence is waning. The latest consumer confidence numbers show that the US electorate are feeling the same way.

That is hardly a surprise, given the utter policy uncertainty around tariffs. Lumber prices, for example, are rising despite weak construction activity – signalling a rush to buy materials ahead of potential levies. Even if it is all “the art of the deal”, uncertainty means people cannot plan ahead and the ‘animal spirit’ cannot be unleashed – a recipe for stagnation. The recent slight rise in corporate credit spreads – the difference between corporate and government bond yields – shows this is a growing risk. These are not recessionary signals, but they suggest we should take the confidence numbers seriously.

At the same time, we know that Trump enjoys his popularity and is an avid stock market watcher. He is likely to react to signs of market or economic weakness – it is one of the reasons US investors like him. If the worrying signs persist, we should expect economic support from the White House.

It is hard to know what form that will take, but it could include the $4.5 trillion, 10 year tax cut package outlined in Congress’s recently passed budget resolution, which we discuss in a separate article. Those would take a while and may not be enough – in most cases they are just an extension of current measures which are set to expire – so we should probably expect some other support too, perhaps in the form of further tariff delays or reprieve.

Tariffs roll off Europe’s back
Americans are not the only ones unsure how to plan for Trump’s presidency. Renowned Trump-whisperer Emmanuel Macron thought he had placated the president enough to support Europe’s case – only for the White House to announce 25% tariffs on imports from the EU just a few days later. This fickle approach has convinced some European leaders that negotiations are futile. This apparently includes the victor of Germany’s election last Sunday, Friedrich Merz.

Despite that negativity, there was no sell-off in European stocks. In fact, price-to-earnings based valuations improved relative to the US. That is because the bullish case for Europe is not built on exports but domestic improvement (with some help from falling energy prices, in expectance of an end to the Ukraine war). Investors hope that defence spending will boost European demand, and perhaps even remove structural barriers to policy. As usual, crisis gives purpose to the ever-closer union, spurring its leaders towards the cohesion and decisiveness that has proved elusive.

German Chancellor-in-waiting Merz wants a Europe independent from the US, but that requires strong and unified leadership. Can his government provide it? The likely CDU-SPD coalition will probably be more stable than the multi-party coalition of Olaf Scholz, but so much depends on how quickly the centre parties can reform Germany’s constitutional debt brake. That needs to happen fast, as defence spending cannot increase without it.

Capital outflows from the US continue
The market trends we have seen over the last month – a weakening dollar, lower US valuations, and strength in Europe and China – can be at least partly explained by shifting growth expectations. But, with the rise of trend investing, we also need to keep an eye on the direction of capital flows. Those are now turning against the US. Even Nvidia’s stellar results were not enough to generate confidence. Incredibly, despite 80% year-on-year profit growth, the chipmaking behemoth’s stock is down this week.

We wrote last week that this could be related to Trump chipping away at the US-led global order, which underlies modern capital markets. This week, the White House released its “America First Investment Policy”, which restricts foreign investment into the US from those with financial ties to China. This will inevitably have second-round impacts on China’s trading partners – the second largest of which is the EU.

Such quasi-capital restrictions are not going to cripple global finance, but there is a limit to how much you can chip away at the world order without serious financial disruption. Those in the White House will no doubt tell their president that and, now that his honeymoon with US investors and the public at large is over, you would bet on a change of tack. Markets expect US growth to slow, but consumers expect inflation to accelerate. Only in the unlikely worst-case scenario (stagflation) can both be right. US Economic indicators – and Trump’s response to them – will be crucial from here.

Markets and the economy at large do not like political confusion, and investors are now voting with their asset allocations. We saw a similar reversal in US markets – and European outperformance – last summer, amid an economic slowdown and worsening US sentiment. The current move is not (yet) as sharp as the summer of 2024. The US central bank (the Fed) has plenty of room to use monetary policy to stem a slow down if needed, just as they did then. And, as we have laid out, the Trump administration is far more likely to reach for fiscal stimulus, rather than let the slowdown continue.

Deteriorating sentiment and capital outflows are denting US exceptionalism – the opposite of putting America First. We would not be surprised by renewed US fiscal and monetary activism. If so, there would almost certainly be a near-term rebound of US capital markets, given that US companies are still expected to have the strongest 2025 earnings growth (relative to other regions).

The first 100 days after inauguration are usually a rosy time for US presidents. Unless Trump acts soon, his honeymoon may be ending rather more abruptly.

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