Trump’s Return To The World Stage Is Already Claiming Numerous Victims

By Elwin de Groot, head of macro strategy at Rabobank

Trump’s return to the world stage – even though his official inauguration is on January 20 – is already claiming numerous victims. Arguably, even the fall of both the French and German government in recent months have been given some impetus by the political events in the US. But one of the clearest victims appears to be Canadian Finance Minister Chrystia Freeland, who resigned yesterday, citing differences with PM Trudeau’s Cabinet over how to prepare for a looming trade war with its big neighbour. Observers say her comments in her resignation letter on “eschewing political gimmicks” likely refer to the temporary tax cuts and pay-checks planned by the government to support consumption. She sees handing out money as fiscally imprudent. Given that she announced her decision just hours before she was due to speak in Parliament on the fiscal and economic outlook, markets reacted with a fall in the Canadian dollar (depreciating some 0.4% vis-à-vis the US dollar) and rising bond yields (some 7bp on the 10y note).

Meanwhile, data this morning showed that UK regular wages increased by 5.2% annually in the three months to October, up from 4.9% previously and surpassing the consensus forecast of 5%. Regular pay growth in the private sector, which is more sensitive to the business cycle and therefore tracked more closely by the Bank of England, even rose to 5.4% during that same period. This significant wage inflation underscores the Bank of England’s dilemma, as economic growth is slowing, as indicated by Friday’s production figures and yesterday’s PMI. Job growth remains weak as well. Vacancies have declined to pre-pandemic levels, while payroll employment stagnant. We remain cautious about the official employment and unemployment data, as even the ONS acknowledges that its current estimates are essentially random. Our base scenario is that the central bank will continue easing in quarterly steps. We expect rates to remain unchanged at Thursday’s meeting and to decrease by 100 basis points over the course of 2025.

Turning back to Europe then, where – to no one’s surprise – German Chancellor Scholz lost yesterday’s confidence vote, putting the country on track for snap elections on February 23. The debate in the run-up to the vote was heated and was first and foremost about the dire state of the economy and the threats from the East (and arguably from the ‘West’ as well). Of course the debate was largely a show for parties to set out their key campaign themes. Scholz said “It’s high time to invest forcefully into our country. […] we must turn the switch and this means now.” Yet one may wonder whether Scholz’ call for more public spending and investment resonated with lawmakers and voters, given that his Cabinet largely failed to do exactly just that under his reign. Indeed, CDU’s Merz responded: “Were you on another planet?” Yet, here too (as well as in France) the core of the issue is whether fiscal policy can and should play a role to support sustainable growth and, if so, how?

As long as this debate is not settled, Europe is likely to remain a playball of the markets, as it has been of late; negative sentiment has driven an wedge between US and European equity prices and has driven Eurodollar near its lowest level since late 2022, when the currency union was still reeling from the energy shock. Indeed, European industry is in a difficult position. Energy-intensive and/or low-added value industries are either closing or moving location to other parts of the world. A renewed decline in the German manufacturing PMI to 42.5 and an eyewatering 41.6 (a fresh cyclical low) in France for December once again drove home that message. The overall Eurozone index stayed put at 45.2, a level normally associated with (mild) recession. 

The manufacturing sector again produced less than a month earlier, and the decline in activity was even the largest so far this year. Production is clearly being scaled back due to declining demand, which is reflected in the subpar inflow of new orders. Especially new export orders continued to decline, and this does not seem to be entirely a Trump effect. Although the fear of import tariffs may make American companies more cautious about placing international orders, the contraction in new orders was less severe than in previous months. The empty order books thus seem more a reflection of the poor competitive position of European industry in the global market. The lower demand and emptying order books are now also forcing more companies to shrink their workforce. According to the purchasing managers’ survey, the number of layoffs has not been this high in the past four years as this month, particularly in Germany and France. However, that sounds worse than it is: the number of job losses is still quite limited. As far as companies were still “hoarding” staff after the earlier experience with staff shortages around the Covid pandemic, some of these layoffs will be a ‘rationalization’ of the number of employees. After all, keeping more employees than necessary is not cheap.

Moreover, structural and cyclical issues are often mixed up and it seems fair to say that US industry isn’t in a great state either. For example, the US manufacturing PMI for December also fell decisively below the boom-bust mark of 50. At 48.4 it is more or less the same level as the November-reading for the much longer-running ISM manufacturing index. In statistical terms the European and US manufacturing indices are actually not very different right now, the normalized difference  is currently less than 0.5 standard-deviations (to the disadvantage of the Eurozone). 

Meanwhile, the Eurozone Services PMI data seemed to confirm what we have been saying for some time, namely that these indices tend to paint too-negative picture of economic activity in the autumn, only to paint too-positive a picture during the spring. This is a ‘seasonal pattern’ where the services sector PMI peaks around mid-year and then weakens between July and November/December appears to have slipped in since 2021 (when the world was slowly recovering from the pandemic). In any case, the December readings were better than the consensus estimate, and this compensated for the weakness in industry, even though the overall picture remains one of (very) moderate growth of activity.

Despite the sluggish activity, respondents of the PMI survey report higher costs and selling prices once again. Prices are no longer rising as sharply as in 2022, but companies have increased their selling prices for the third consecutive month. This price pressure remains particularly problematic in the services sector, suggesting that costs are largely related to salaries.

This underscores the challenge for the European Central Bank once again. Just last week, President Lagarde stated that domestically-driven inflation remains high. This measure of inflation, which tries to exclude the effects of imports, was still 4.2% in October. This inflation is closely related to services inflation and labor costs, which are also decreasing very slowly. The ECB still assumes that the high wage increases and high services inflation are the result of the high inflation in recent years, leading to higher collective labor agreements now. The ECB expects this to decrease next year. The PMI survey did not provide reassurance in this regard yesterday.