Policy Game Before Trump's Inauguration

Abstract

Core Viewpoints

Donald Trump will officially take office as President of the United States on January 20. Recently, discussions surrounding the economy, tariffs, and geopolitics after Trump's inauguration have noticeably intensified, and Trump's personal style has further increased uncertainty. The debt ceiling controversy, trade tariff policies, and the slower-than-expected progress in the Russia-Ukraine conflict have intensified market speculation, amplifying global asset price volatility. Additionally, strong U.S. economic data has significantly reduced expectations for Federal Reserve interest rate cuts, with a strong dollar and high U.S. Treasury yields suppressing the performance of global risk assets. Under the backdrop of geopolitical conflicts, tariff disturbances, and rising U.S. inflation expectations, commodity assets have shown some signs of recovery, but sustainability remains to be observed. It is recommended to maintain operational flexibility, enhance sensitivity to macro data and policies, and seize opportunities from the overshooting of certain assets.

Core Theme: Policy Game Before Trump's Inauguration

The domestic policy game in the U.S. mainly revolves around the debt ceiling, fiscal policy, and Federal Reserve monetary policy. The fiscal deficit is one of the focal points of Trump's 2.0 policy game. Trump's proposed suspension of the debt ceiling has not been approved by Congress, and Elon Musk's acknowledgment that the $2 trillion spending cut target cannot be achieved indicates significant uncertainty in the fiscal outlook. How the Federal Reserve responds to the impact of Trump's 2.0 is also of market concern, and the recent hawkish shift by the Federal Reserve adds another layer of complexity to the domestic policy game. The international policy game mainly revolves around trade tariffs and geopolitical issues. Whether it is Trump's own statements on tariffs and geopolitical situations or the Biden administration's recent measures to escalate restrictions on AI chips and the Russian energy sector, these objectively increase the complexity and uncertainty of international competition.

Market Condition Assessment: Increased Disturbance from Trump's Tariff Remarks, Adjustment of Federal Reserve Rate Cut Expectations

The strength of domestic demand remains to be repaired, with the policy-driven characteristics of consumption still evident, and the momentum of price signals remains to be observed, while overseas market disturbances have increased. U.S. employment data exceeded expectations, leading the market to further lower rate cut expectations, with Trump's tariff remarks disturbing the market. In terms of monetary policy, China's central bank has reiterated the concept of "funds idling" and released a firm signal to defend the exchange rate, which may indicate a marginal change in monetary policy stance. Rate cut expectations have slightly cooled, but the main tone remains "moderately loose," "timely rate cuts," and "increasing regulatory intensity." In terms of fiscal policy, through large-scale equipment updates and consumption replacement policies, further expansion of domestic demand is pursued, while also emphasizing the sustainability of fiscal policy to leave room for potential external disturbances. In terms of real estate policy, special bonds are used to support the acquisition of existing commercial housing and activate idle land to stabilize the housing market and promote circulation.

Allocation Suggestions: Strong Dollar and High U.S. Treasury Yields Suppress Global Risk Assets, Seize Opportunities from Overshooting of Certain Assets

The significant retreat in U.S. rate cut expectations, combined with the disturbances from Trump's impending inauguration, has led to a strong dollar and high U.S. Treasury yields suppressing global risk assets. The bond market is advised to adopt a wait-and-see approach before the holiday, with short-term interest rate risks being released. It is suggested to hold cash in certificates of deposit, 7-year government bonds, and slightly longer-duration credit bonds, while continuing to trade with ultra-long-term rate bonds. The stock market may maintain volatility, with technology remaining a mid-term theme, focusing on machinery exports and consumption benefiting from policies, while being cautious towards high-dividend sectors. U.S. Treasury yields may continue their upward inertia in the short term, and in terms of allocation, it is recommended to maintain a defensive counterattack approach, balancing duration U.S. stocks are cautious before the trend of U.S. Treasury yields becomes clear, waiting for the implementation of Trump's policies and opportunities for a decline in Treasury yields. Gold still has high allocation value, oil prices are highly volatile in the short term, copper may turn into fluctuations, and domestic commodities may have local rebound opportunities after short-term adjustments, while medium to long-term trends may be weak and fluctuating.

Follow-up focus: Chinese economic data, Trump's official inauguration

Domestic: 1) China's December Swift RMB share in global payments; 2) China's GDP growth rate for the whole year of 2024, year-on-year GDP for the fourth quarter; 3) China's December retail sales of consumer goods year-on-year, December industrial added value above designated size year-on-year,

Overseas: 1) U.S. December New York Fed 1-year inflation expectations; 2) December NFIB small business confidence index; 3) January New York Fed manufacturing index; 4) Initial jobless claims for the week ending January 11; 5) EIA crude oil inventory (10,000 barrels) for the week ending January 10.

Risk warning: U.S. inflation exceeds expectations again, geopolitical tensions continue.

Main Text

Policy Game Before Trump's Inauguration

Trump will officially take office as President of the United States on January 20. According to the Associated Press, on his first day in office, Trump may introduce more than 100 executive orders. Recently, discussions surrounding Trump's post-inauguration economy, tariffs, and geopolitics have noticeably intensified, and Trump's personal style has further increased uncertainty. Global asset price fluctuations have amplified, the U.S. dollar and Treasury yields have risen, non-U.S. currencies are generally under pressure, U.S. stocks have fluctuated and declined, while gold and oil have strengthened. The debt ceiling dispute, trade tariff policies, and the progress of the Russia-Ukraine conflict not meeting expectations have intensified market games.

First, the domestic policy game in the U.S. mainly revolves around the debt ceiling, fiscal policy, and Federal Reserve monetary policy. The fiscal deficit is one of the focal points of Trump's 2.0 policy game. The proposed suspension of the debt ceiling by Trump has not been passed by Congress, and Musk has acknowledged that the target of $2 trillion in spending cuts cannot be achieved, indicating significant uncertainty in the fiscal outlook, with both upward and downward risks potentially existing simultaneously.

Although the Republican Party holds a majority in both houses, creating a seemingly "three powers unified" situation, the advantage is not actually significant. Recent disputes surrounding the debt ceiling show that the advancement of Trump's subsequent tax cuts and other plans may require support from moderate Republicans; otherwise, they may face certain obstacles. The divisions within the Republican Party mainly reflect differing priorities in fiscal policy. Conservatives tend to favor significant cuts in federal spending, especially in social welfare and education, while moderates are more inclined to maintain current spending levels to avoid excessive impact on middle- and low-income voters. Additionally, Trump's planned new round of tax cuts, particularly tax reductions for corporations and high-income individuals, may also face opposition from moderates. Moderates are concerned that further tax cuts could exacerbate the fiscal deficit issue and be perceived by voters as favoring the wealthy, thereby weakening the Republican Party's support base among middle-class and low-income voters To promote the tax reduction plan, Trump may need to make compromises in areas such as infrastructure investment or defense spending to gain support from moderates. However, even so, the coordination challenges within the party may still become a significant constraint on Trump's governance.

Musk admits that the $2 trillion spending cut target is unattainable, indicating a lack of substantial reduction in U.S. fiscal spending, which also means that the deficit may remain at a high level for a long time. In the structure of U.S. fiscal spending, Social Security, Medicare, and defense spending account for a large proportion, and cutting expenditures in these areas faces significant political resistance. The reduction proposals put forward by conservative Republicans mainly focus on decreasing spending in education, environmental protection, and other non-defense areas, but the budget share of these departments is relatively small, and their impact on the overall deficit may be limited. Additionally, with the ongoing Russia-Ukraine conflict and escalating geopolitical tensions, significant cuts to the defense budget may be difficult to achieve. At the same time, the high interest rate environment further increases the federal government's interest expenditures, making the fiscal deficit issue even more severe. The expectation that the U.S. fiscal deficit will remain high in the coming years not only exerts long-term pressure on the U.S. Treasury market but may also undermine the status of the U.S. dollar, increasing uncertainty in the global market.

How the Federal Reserve responds to the impacts brought by Trump 2.0 is also a focus of the market. Recently, with strong fundamentals and inflation risks, the Federal Reserve has shifted to a hawkish stance, adding another layer of complexity to domestic policy games in the U.S. The U.S. non-farm payroll data for December showed strong performance, with new job numbers far exceeding market expectations and an unemployment rate lower than expected, indicating that the labor market remains resilient. Coupled with recent hawkish statements from Federal Reserve officials emphasizing that inflation risks still exist and that economic visibility is decreasing, the market has significantly lowered its expectations for interest rate cuts. Looking ahead, the uncertainty of Trump's fiscal policy combined with the trend of rising long-term neutral interest rates will make the Federal Reserve's decision-making more cautious. Recently, U.S. Treasury yields have continued to rise and volatility has increased, reflecting market concerns about inflation and interest rate prospects.

Secondly, international policy games mainly revolve around trade tariffs and geopolitical issues. Whether it is Trump's own statements regarding tariffs and geopolitical situations or the Biden administration's recent measures to escalate restrictions on AI chips and the Russian energy sector, these have objectively increased the complexity and uncertainty of international games.

Trump has recently made frequent statements regarding tariffs, denying reports that the tariff plan may be discounted, and reaffirming his tough stance on tariffs. Concerns about escalating trade frictions have intensified, leading to increased volatility in global risk assets. Trump's tariff policy is not only an economic tool but also a means of political maneuvering. By raising tariffs, Trump aims to compel major trading partners to make more concessions in negotiations while demonstrating his "America First" economic stance to domestic voters However, the market is more concerned about the rising inflation levels and the risks of increasing global supply chain pressures. The specific implementation effects of tariffs will depend on how the Trump administration finds a balance between domestic inflation pressures, international negotiation leverage, and market stability. The current policy visibility is low, leading to heightened market risk aversion and increased asset volatility.

In terms of geopolitics, the progress of Russia-Ukraine negotiations may be slower than expected, and Trump's "ambitions" regarding Greenland and even Canada may exacerbate market tensions, making international games more complex, with attention on the responses and measures of non-U.S. countries. The Biden administration's sanctions against Russia have intensified tensions, complicating the future trajectory of the Russia-Ukraine situation, with Trump admitting that the timeline for resolving the Russia-Ukraine conflict has been pushed back from "the first day in office" to "six months after taking office." The tense geopolitical situation has raised concerns about energy supply, driving up oil and natural gas prices. The strategic game between the U.S., NATO, and Russia will continue to shape the global energy market and geopolitical landscape. For non-U.S. countries, in addition to trade measures such as tariffs, adjusting U.S. Treasury holdings may also become a bargaining chip in negotiations and games with the U.S., potentially putting upward pressure on U.S. Treasury yields.

Weekly Allocation Suggestions

1. Major Asset Classes: With strong U.S. economic data and a significant decline in interest rate cut expectations, coupled with the disturbances brought by Trump's impending inauguration, a strong dollar and high U.S. Treasury yields are suppressing the performance of global risk assets. Under the backdrop of geopolitical conflicts, tariff disturbances, and rising U.S. inflation expectations, commodity assets have shown some recovery, but sustainability remains to be seen. It is recommended to maintain operational flexibility, increase sensitivity to macro data and policies, and seize opportunities after some assets have over-adjusted.

2. Domestic Bond Market: This year's bond market has shown a "high starting point." Recently, there have been marginal changes in regulatory attitudes and interest rate cut expectations, with risk appetite still being a supporting factor, necessitating attention to risk management. Before the Spring Festival, the bond market is in a fundamental and policy vacuum period, with interest rates oscillating at low levels, suggesting a cautious approach. After the festival, focus will be on Trump's policies, financial data, Two Sessions policies, supply, etc., with increased volatility. Short-term interest rate risks have been somewhat released, with certificates of deposit, 7-year government bonds, and slightly longer-duration credit bonds serving as the base, while continuing to trade with ultra-long-term interest rate bonds.

3. Domestic Stock Market: Recent changes in the external environment have been somewhat unfavorable, and expectations for ample domestic liquidity have also slightly adjusted, with the nature of stock market adjustments shifting from "risk release" to "expectation correction." However, favorable conditions such as a positive policy tone and low opportunity costs in the stock market remain, and the basic judgment of stock market fluctuations does not need to change. Technology remains a mid-term theme, continuing to explore opportunities around AI, semiconductors, robotics, and gaming. In manufacturing, attention can be paid to mechanical exports (betting on increased North American capital expenditures), while consumption should continue to focus on policy beneficiaries, with a cautious stance on high-dividend sectors during the interest rate adjustment phase.

4. U.S. Treasuries: The December non-farm payroll data exceeded expectations + rising commodity prices have strengthened concerns about re-inflation, leading the market to quickly lower expectations for Federal Reserve interest rate cuts, causing U.S. Treasury yields to rise, while expectations for Trump's policies further amplify volatility From the perspective of the forward short-end interest rate + term premium framework, the expectation for interest rate cuts in 2025 is only about once left + the term premium of U.S. Treasuries is at a nearly 10-year high, suggesting that long-end rates may have already priced in the strong fundamentals + Trump 2.0 disturbances relatively fully. In the medium term, the upward space for U.S. Treasury rates may be smaller than the downward space. However, the fundamental trend has not reversed + the transmission of tightened financial conditions to the real economy still requires time + the uncertainty of Trump 2.0 remains to be released. In the short term, interest rates may continue their upward inertia, with attention on this week's CPI data. U.S. Treasuries are still on the left side, and in terms of allocation, it is recommended to maintain a defensive counterattack approach, paying attention to preserving ammunition and controlling costs. Previously, we believed that the short end had higher certainty, but with the recent widening of the term spread, a more balanced duration may be needed.

5. U.S. Stocks: The significant rise in U.S. Treasury rates suppresses market risk appetite, and U.S. stocks have entered a "good news is bad news" phase, where stronger economic data is actually bearish for U.S. stocks. Once U.S. Treasury rates exceed 4.5%, the correlation between U.S. stocks and bonds turns significantly positive, with high rates putting pressure on U.S. stock valuations. Under high valuations, the vulnerability of U.S. stocks increases, but a decline still requires a trigger. If inflation continues to rise due to tariffs and other factors, the risk of stagflation trading cannot be ruled out, which would be unfavorable for U.S. stocks; however, if U.S. Treasury rates can pull back, U.S. stocks may return to a soft landing logic. U.S. Treasury rates remain an important variable determining U.S. stock trends, and before the interest rate trend becomes clear, we are slightly cautious about U.S. stocks and do not recommend rushing to increase positions, waiting for the implementation of policies after Trump's inauguration, and paying attention to opportunities for U.S. Treasury rates to decline.

6. Commodities: In a strong dollar environment, most commodities are rising against the trend, reflecting characteristics of a re-inflation trade. However, the driving factors may stem more from supply disruptions, with demand not showing significant recovery, and the sustainability of the rise remains to be observed. First, the geopolitical situation is heating up, with Biden restricting U.S. offshore oil production and fully sanctioning the Russian energy sector, significantly pushing up oil prices; second, Trump's potential tariff proposals lead U.S. companies to stockpile imports; Comex copper is at a high premium relative to LME copper; third, strong U.S. economic data raises inflation expectations. Looking ahead, gold still has high allocation value in an uncertain environment, and it is recommended to allocate during adjustments; oil prices are significantly priced due to tightening supply, and Trump's proposals bring considerable uncertainty, leading to large short-term fluctuations in oil prices; copper may rebound from the bottom and then turn into fluctuations, waiting for a substantial recovery in the global manufacturing cycle; domestic commodity supply and demand contradictions still need to be resolved, and after continuous price adjustments, there may be localized rebound opportunities, with medium to long-term fluctuations likely to be weak.

Market Condition Assessment

Macroeconomic Quadrant:

Domestic: The strength of the demand side remains to be repaired, with the policy-driven characteristics of consumption still evident, and the momentum of price signals remains to be observed, while overseas market disturbances increase. In December, the CPI rose 0.1% year-on-year, and the CPI for the whole year of 2024 is expected to rise 0.2%, the same increase as the previous year; in terms of PPI, affected by some industries entering the production off-season and fluctuations in international commodity prices, the PPI in December fell 2.3% year-on-year, and the PPI for the whole year of 2024 is expected to decline 2.2%, a decrease of 0.8 percentage points compared to the previous year. Supported by overseas markets and export demand, December exports rose 10.7% year-on-year, higher than expected, and increased 7.5% month-on-month, stronger than seasonal levels Overseas: U.S. employment data exceeded expectations, leading the market to further lower interest rate cut expectations, while Trump's tariff remarks disturbed the market. The U.S. December ISM Manufacturing Index was 49.3, reaching a nine-month high, higher than expected but still in the contraction zone; November JOLTs job openings data recorded 8.098 million, exceeding market expectations, with the previous value revised up; December seasonally adjusted non-farm payrolls were 256,000, significantly surpassing the market expectation of 160,000, reaching a new high since March 2024, with private sector hiring accelerating, increasing resistance to Fed rate cuts, and the Fed's meeting minutes indicating rising inflation risks, suggesting a potential slowdown in rate cuts in the future. According to Bloomberg, on January 12, the OIS market expected a 2.9% probability of a 25bp rate cut by the Fed in January, and a 28.2bp cut in 2025. The Eurozone manufacturing PMI continued to be in the contraction zone, and the UK's December manufacturing PMI fell to a nearly one-year low.

Domestic Policy Judgments:

Monetary Policy: The central bank reiterated the concept of "funds idling" and released a strong signal to defend the exchange rate, which may indicate a marginal change in monetary policy stance, with rate cut expectations slightly cooling, but the main tone remains "moderately loose," "timely reserve requirement ratio and interest rate cuts," and "increasing regulatory intensity." To cope with the increased pressure of RMB exchange rate fluctuations at the beginning of the year, the central bank issued 60 billion offshore central bank bills in Hong Kong, signaling its firm commitment to maintaining exchange rate stability. However, the main tone of this year's monetary policy remains "moderately loose," "timely reserve requirement ratio and interest rate cuts," and "increasing regulatory intensity," and the current weak financing demand combined with high real interest rates supports the central bank's rate cuts, with the only difference being when and by how much. It is expected that before the large-scale issuance of government bonds (typically after the March Two Sessions), the central bank may continue to pause bond purchases, potentially replacing it with reserve requirement ratio cuts, and the liquidity before the festival is likely to remain stable.

Fiscal Policy: Through large-scale equipment updates and a trade-in policy for consumer goods, further expand domestic demand while emphasizing the sustainability of fiscal policy to leave room for potential external disturbances. On January 8, the National Development and Reform Commission and the Ministry of Finance issued a notice on "Implementing Large-Scale Equipment Updates and Trade-In Policies for Consumer Goods in 2025," increasing subsidies for durable goods such as automobiles, home appliances, and mobile phones, with the central government having pre-allocated 81 billion yuan for the trade-in policy for consumer goods in 2025. The policy effects are expected to continue to manifest this year, but attention should be paid to the potential "overdraft effect" on consumption; there is significant potential for subsidies for non-durable goods and service consumption, with notable incremental effects, which may become an important marginal force driving consumption. On January 10, during a press conference, the Ministry of Finance emphasized that "the deficit ratio should comprehensively assess the long-term sustainability of finances," and "will closely monitor international and domestic situations, and gradually introduce policy 'backstops'" to reserve policy space to respond to complex internal and external situations.

Real Estate Policy: Support the acquisition of existing commercial housing and activate idle land through special bonds to stabilize the housing market and promote circulation. On January 10, during a State Council press conference, it was mentioned that within the newly issued special bond quota in 2025, local governments can arrange special bond projects for land reserves and the acquisition of existing commercial housing for affordable housing as needed, with policy effects gradually being released in 2025 Specifically, the idle land stock that is to be stored using special bonds must meet two conditions: first, it must be transferred before the second quarter of 2024; second, it must be included in the list of idle land under dynamic supervision in the land market. This move will help improve the supply-demand relationship of land, enhance the liquidity of real estate companies, promote the real estate market into a new cycle, and further facilitate the release of effective demand.

Author of this article: Zhang Jiqiang S0570518110002, Tao Ye, et al., Source: Huatai Securities Fixed Income Research, Original title: "[Huatai Asset Allocation] Policy Game Before Trump's Inauguration"

Risk Warning and Disclaimer

The market has risks, and investment should be cautious. This article does not constitute personal investment advice and does not take into account the specific investment goals, financial conditions, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are consistent with their specific circumstances. Investment based on this is at one's own risk