Bringing production jobs back into an already tight US labour market is more likely to push up inflation than create GDP growth, in our view. This would drive up rates and the USD, and limit EPS growth.
Overall, financial conditions remain supportive despite the recent rise in real yields in the eurozone. Our financial indicators are largely stable, with credit spreads still reasonably tight and Libor-OIS spreads narrowing. Last week’s US employment report signalled lower wages and higher unemployment rates despite strong job growth as labour market participation increased.
Going forward, however, we think the participation rate is unlikely to rebound meaningfully, suggesting the US labour market is tight. This gives us confidence in our reflation theme. The impact of a border adjustment tax would be very bullish for the USD according to our analysis: the USD could appreciate rapidly and by 12%-25%, we think.
Recent balance sheet data confirm that US banks are better positioned than their European counterparts to benefit from the reflation trade. Overall position: The early details of the Trump administration and the current state of the US labour market suggest to us that the reflation trade is not fully priced by markets.
Our conviction that the USD will rise is even stronger, and we think interest rate markets are complacent. Both these factors are headwinds for equities. The weaker EUR should support EPS growth in Europe, but the rising political risks are a headwind, especially for banks.
