Octobre 2016 – Trump et les marchés européens du crédit

Little doubt that Donald Trump’s victory in the US Presidential election combined the Republican sweep of Congress surprised many in financial markets and that such outcome was not factored in most investors’ portfolios. Using our glasses of European credit specialists, we see the impact of this event in many parts of our current investment outlook, but only via indirect channels for the moment. Importantly, we remain constructive on European credit fundamentals and continue to see downside risks to our investment framework in areas where the impact of the election results may be initially limited, namely Brexit developments, worsening corporate credit fundamentals and bubble-like valuations in some buckets of European fixed income markets. However, some policy changes by the newly-elected US Administration will likely have implications on European credit, especially via three transmission mechanisms.

 The economic channel

It remains to be seen whether a Trump Administration will create upside or downside risk for the currently benign US economic outlook. What is certain though, is that the US is by far Europe’s largest trading partner in goods and services and that sizeable capital flows and FDI have taken place between both regions for decades. In particular, some countries such as the UK, Germany and Ireland have significant exposures to the US economy. Overall, if a faster-growing US economy cannot be viewed negatively for European credit, a slower-growing US economy will likely have negative consequences for our asset class. We note that the European economy seems quite resilient at the moment – see the lack of negative impact following the Brexit vote for the moment – and that the outlook for European corporate profits remains moderately favorable. All this makes us confident that the economic channel will not be an immediate driver of change for European credit, but also creates greater uncertainty – both positive and negative – regarding the European macro environment over the medium term.

 The central bank policy and yield channel

It is not clear at this stage what a Trump Administration means in terms of Fed policy. On the back of the recent set of strong economic data, it is expected that the Fed will hike rates in December. But should the US engage into a very accommodative fiscal policy with its accompanying inflation risks, US yields may rise significantly and the Fed turn more hawkish. On the European side, the expectation remains for a sub-par inflation outlook and for the continuation of the very accommodative ECB policies over the medium term, but without major fiscal impulse. So, we may end up quite soon with an even more diverging rate/yield environment between the US and Europe than now, which would in turn create significant risks for European fixed income markets.

 The international relation and political risk channels

Protectionism and some controversial non-economic policies may be the hallmark of the new US Administration at the beginning of Mr. Trump’s mandate. New US trade and security policies could well have an impact on trade flows between Europe and its major trading partners, on protectionist policies in the EU and on the upcoming Brexit negotiations. Radical changes in US foreign policies could also create more headline risk and increase investor risk aversion in capital markets. With some important elections coming up in the next few months – Italian referendum, Dutch, French and German general elections, to name a few – political risk will have to be repriced in financial assets; for sure, European credit will not be immune to that. Although the same political forces behind the Brexit and Trump votes are also at work in the EU, it is too early to tell to which extent they will drive an agenda change in the European economic and financial policies. However, we believe that European credit markets will look at such risks with much greater care going forward.

 Mildly positive implications for European credit but with greater tail risk

Overall, the transmission channels of the risks related to the recent US election for European credit are not expected to destabilize European credit markets in the short term. Quite the contrary, to the extent that the US economic growth accelerates, that legislation allowing offshore cash repatriation from US corporate gets passed and that US corporate revenues and earnings grow, we would see the election outcome as a positive for European credit fundamentals. Importantly for banks, the prospects of a steeper yield curve in USD and of a less stringent regulatory environment could help them address their current profitability issues and strengthen their credit profiles further. One caveat to our short-term constructive view on European credit relates to names with significant EM exposures, as the expectation of more protectionist policies from the US combined with the current volatility for some EM currencies and higher US rates do not bode well for EM countries in the short to medium term. Over time, the probability of greater imbalances in the US as well as between the US and Europe may increase the risk of tail events and of sudden bouts of high risk aversion across all financial markets.