Finance Associated Press Nov 12 - From the performance of the financial markets, the first week after this year's US presidential election is undoubtedly historic - the market seems to have not fully factored in the expectation of Trump's victory or a Republican wave before the election.

Therefore, people can see that the three major US stock indexes have further reached new historical highs after the election, and bitcoin has even approached $90,000 all the way, while the investment-grade bond spread has reached the narrowest level since 1998. Obviously, the market's risk appetite is very high - at least for now.

So, besides the overall bullish market performance in the short term, what insights can we gain from the results of this US election for the future direction of the economy and financial markets?

Deutsche Bank strategist Henry Allen, in a recent research report, listed the 'four key points' that investors should pay attention to after the election (some of which may actually make investors more cautious). Now, let's take a quick look:

Key point ①: Inflation risks will continue to rise

Allen expects that due to the tariffs and fiscal stimulus measures that Trump may implement, inflation risks will continue to rise. In addition, central banks around the world have already been implementing loose policies, while economic growth data has unexpectedly improved. Therefore, inflation will be a prominent concern and may prompt the Fed to take a more hawkish stance.

It is worth mentioning that Deutsche Bank has been warning of inflation risks for the past few months. Since the bank issued a warning report in September, the 2-year US inflation swap has risen by nearly 50 basis points.

Here are the four reasons deutsche bank believes that inflation risks will further rise:

The first reason is tariffs. Obviously, the specific implementation of these tariff measures and to what extent negotiations will be conducted still remain to be observed. However, Trump has been calling for an increase in tariffs during his campaign, far beyond the levels of his first term, including imposing tariffs on all imported commodities. Implementing tariffs comprehensively may lead to a 0.75 to 2.5 percentage points increase in the core inflation rate in the USA.

The second reason is fiscal stimulus, as the extension of Trump's first-term tax cuts (set to expire by the end of 2025) will further boost demand, especially if additional tax cuts are implemented on this basis. In fact, people can see how Biden's fiscal stimulus measures in the 2021 American Rescue Plan have led to rising inflation, especially in economies already facing supply constraints post the COVID-19 pandemic. Compared to Trump's first election victory in 2016, the USA's unemployment rate is lower, and the inflation rate is higher now, hence, on the surface it appears that there is less idle capacity in the economy.

Thirdly, current inflation risks are already quite high, especially as global central banks are easing policies and the money supply growth is accelerating. Since the September meeting, the Federal Reserve has cut rates by 75 basis points. We know that the operation of monetary policy has a lagging effect, so the impact will continue into next year. In addition, Federal Reserve Chair Powell himself stated last week, "Our baseline expectation is that we will continue to gradually lower rates to a neutral level." Historically, when central banks ease policies, it is often a time that requires caution, as inflation may rise as a result.

Fourthly, ever since the market turbulence this summer, US data has generally been surprisingly positive. For example, the October ISM Services Index reached its highest point in two years at 56.0. The unemployment rate has decreased by 0.2 percentage points since its recent high point in July. The overall market conditions remain very accommodative, with the S&P 500 Index reaching historic highs and credit spreads at their narrowest levels in years.

Allen believes that the risk of rising inflation is not an unfounded concern, as some investors have already realized. In fact, as of last Friday's close, the US two-year inflation swap rate has risen from a recent low of 1.98% on September 6 to 2.62%.

Key Point 2: The current financial environment is vastly different from when Trump won his first term in 2016.

Allen states that the current financial environment is vastly different from when Trump won his first term in 2016. With the rise in US bond yields and increased federal debt, the fiscal space has become more constrained, while asset valuations are much higher. Although many are using the 2016 strategies to analyze what is happening now, the reality is that the situation in 2024 will be different.

First, the fiscal sector in the USA will face more restrictions. The level of federal debt has risen significantly, with the Congressional Budget Office estimating that US debt as a percentage of GDP will soon exceed the post-World War II record. Additionally, both nominal and real interest rates have increased, making borrowing costs higher now than eight years ago. For example, the real yield on 10-year US Treasury bonds closed at 1.94% last Friday, compared to only 0.25% at the end of the week when Trump won the election in 2016.

Secondly, market valuations are being calculated from a higher base, making it theoretically more difficult to achieve rapid growth than in 2016. In terms of stocks, the S&P 500 index actually fell by 0.7% in 2015, but by the end of October in 2016, just before Trump's victory, the index had only risen by 4.0%. In contrast, the S&P 500 index rose by 24% in 2023, and as of the end of October, it has increased by 19.6% this year. The cyclically adjusted PE ratio (CAPE) was 26.54 times in October 2016, but had risen to 36.85 times by October 2024.

As of last Friday, the spread on US high yield bonds has narrowed to just 256 basis points, the lowest level since June 2007 (before the global financial crisis erupted). In addition, the spread on US investment grade bonds is only 74 basis points, the lowest level since May 1998.

Thirdly, inflation was not a significant risk in 2016—US inflation has been low since the global financial crisis of 2008. When Trump was elected president that year, the federal funds rate was still in the low range of 0.25-0.5%, reaching a maximum of 2.25-2.5% during his term. In comparison, rates were already above 4% at the beginning of Trump's term.

Therefore, Allen believes that from every indicator, the financial and economic situation is more severe now than when Trump took office, with higher inflation, more restrictive monetary policy, higher asset valuations, and a more challenging debt situation.

Key Point 3: The risk of a US debt ceiling crisis occurring in the next two years has been greatly reduced.

Of course, one good news for the market is that assuming a 'Trump Red Wave' occurs (Trump wins the election and the Republicans control both houses of Congress), the risk of a debt ceiling crisis in the next two years will be significantly reduced.

Allen stated that extending the debt limit requires legislation from Congress, which will be much easier in a unified government controlled by a single party. Furthermore, considering that default could trigger a financial crisis and economic recession, there is a strong political motivation to avoid default.

In recent years, the US debt ceiling crises (such as in 2011 or 2023) have occurred during government divisions, and this is no coincidence. However, if people truly see the Republican Party winning by a large margin, then the debt ceiling will not be the main political issue in the coming years.

Key Point ④: Political instability in the USA is starting to become the new normal.

Allen points out, please remember, the political situation in the USA has been very unstable in recent years: out of the past 10 presidential elections/midterm elections, there have been 9 instances where the control of the White House/Senate/House of Representatives has changed. Therefore, the pace of change in the political landscape may be faster than many people expect.

Over the past 20 years, there have been significant changes in the US political landscape. In 2004, George W. Bush won a second term, and the Republicans controlled the Presidency and both houses of Congress. However, in 2006, the Democrats regained control of both houses of Congress, and under Barack Obama's leadership in 2008, they regained the Presidency. Subsequently, in 2010, the Republicans took back the House of Representatives, in 2014 they regained the Senate, and during Trump's presidency in 2016, they again won the White House - after 12 years, the Republicans once again had a major victory. However, the Democrats won the House of Representatives in 2018, regained the Presidency in 2020, and after the results of the Senate runoff election in Georgia were announced, they also got control of the Senate. In 2022, the Republicans took back the House of Representatives, and in 2024 they won the White House and the Senate (as of the writing of this article, the Republicans are a few votes away from winning the House of Representatives election).

Allen states that fundamentally, the key issue is that political turmoil has been intensifying in recent years, and 2024 is a bad time for current presidents around the world. Although the current changes in the political landscape may appear drastic, the situation could rapidly shift back and forth.

Allen points out that these increasingly frequent political changes starkly contrast with the several decades after World War II when the party combinations of the US President/Senate/House of Representatives typically remained unchanged for 4 to 8 years.

Editor/Lambor