Equities and Bonds Diverge Amid Economic and Political Uncertainty

Thanksgiving week in the US often brings quieter markets, but last week saw notable volatility. Political developments in France weighed on its equities, while emerging markets felt the impact of renewed tariff rhetoric from Donald Trump. Meanwhile, Japanese equities fluctuated inversely to the yen, and US bond yields dropped following Trump’s nomination of Scott Bessent as Treasury Secretary. Bessent’s “3-3-3 Plan” (explained below) has been interpreted as positive for both stocks and bonds.

Despite lower US bond yields, inflation-adjusted metrics also declined, suggesting weaker investor confidence in sustained growth plans. If inflation remains subdued, accommodative Federal Reserve interest rates may support private borrowers and reduce the government’s debt burden.

This environment presents opportunities for Europe, where energy prices have remained approximately four times higher than in the US. If Trump’s plans succeed in reducing US energy prices, Europe could benefit disproportionately, potentially spurring economic growth. However, the broader political landscape dampens optimism. In France, Prime Minister Barnier’s reversal of an electricity tax under pressure from Le Pen’s RN party highlights governance challenges, while structural instability across Europe could enable populist parties to gain influence in upcoming elections.

The challenge for governments across Europe, the UK, and the US lies in balancing budgetary tightening with job preservation. Economic instability and fragmented political alliances add complexity to this effort, leaving investors wary. Nonetheless, some indicators of economic optimism remain, even as markets brace for potential volatility from unexpected negative news.

The Impact of Tariff Threats

Trump’s renewed tariff threats have reignited concerns in North American trade and global markets. His pledge to impose 25% tariffs on Canadian and Mexican goods, citing fentanyl-related concerns, would violate the USMCA trade deal he previously signed. Mexican President Sheinbaum has promised retaliatory measures, while Canada has taken a more diplomatic stance. Trump has also hinted at additional 10% tariffs on Chinese goods, although specifics remain unclear.

Canada and Mexico are critical to US trade, purchasing $560 billion in exports last year, more than China. While Trump’s goal is to replace foreign imports with domestic production, many goods and services cannot be easily substituted. Businesses—both domestic and international—could face severe challenges from abrupt tariff implementation. Moreover, a weaker Mexican economy may exacerbate migration pressures on the US border, and retaliatory trade measures from other nations could target US tech companies, jeopardizing a significant source of economic strength.

While Trump’s statements likely reflect negotiation tactics rather than fixed policy, frequent tariff threats risk destabilizing markets. Investors would do well to recall the guiding principle of his previous term: take Trump’s rhetoric seriously, but not literally.

Scott Bessent’s “3-3-3” Plan for the US Economy

Scott Bessent, Trump’s pick for Treasury Secretary, has proposed an ambitious “3-3-3 Plan”: reduce the budget deficit to 3% of GDP, achieve 3% economic growth, and increase energy production by the equivalent of 3 million barrels of oil per day. The strategy is inspired by Japan’s “three arrows” policy under Shinzo Abe but diverges significantly, especially in its fiscal conservatism.

The energy component aims to reduce prices through increased production, though achieving this balance may be challenging. For example, nuclear energy initiatives, while promising, require timelines beyond Trump’s term to fully materialize. Rather than a strict production goal, this aspect of the plan appears focused on price reductions.

The 3% growth target is historically feasible (recent US growth has averaged 2.7%), but Bessent’s simultaneous emphasis on deficit reduction complicates matters. While deregulation has driven past growth—most notably during Reagan’s presidency—Reagan’s success was partially due to expanded deficit spending. Achieving deficit reduction alongside growth may prove unrealistic given the US debt-to-GDP ratio now exceeds 120%, compared to 40% during Reagan’s tenure.

Reducing the deficit to 3% of GDP by 2028, as Bessent proposes, faces significant obstacles. Current government expenditure cuts may negatively impact growth, and the assumption that tax cuts will offset revenue shortfalls is speculative at best. With rising interest costs and high debt levels, simultaneous achievement of all three goals under the 3-3-3 Plan is unlikely.

Markets have responded positively to Bessent’s appointment, appreciating his goals as aspirational. However, as with other aspects of Trump’s economic policy, the market must approach these objectives seriously but not literally.

Conclusion

Political turbulence, trade uncertainties, and ambitious economic policies are shaping a complex investment landscape. While there are glimmers of optimism—such as potential benefits from reduced energy prices—persistent risks remain. European political fragmentation, tariff threats, and the ambitious nature of Bessent’s 3-3-3 Plan underscore the need for cautious optimism. Investors should remain vigilant, balancing opportunities against the backdrop of ongoing volatility.

Important

This article is for information purposes only – should not be perceived as financial advice. We recommend you should always speak to a financial adviser before making any investment decisions.

Please note, past performance is not a reliable indicator to future returns. Your investment may fall as well as rise, and you may not get back what you put in.