Inflation Concerns Affect US and European Markets

US Inflation, Mexican Prospects, and Trump’s Legal Woes: A Complex Financial Web

by Faruk Imamovic
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Inflation Concerns Affect US and European Markets
© Getty Images/Spencer Platt

The financial landscape today is riddled with complexities, from the US inflation dynamics to the political intricacies affecting international markets. A crucial element in this puzzle is the Personal Consumption Expenditures Price Index (PCE PI), a key indicator for gauging inflation in the United States. If the upcoming core PCE print aligns with expectations (0.3%), it will represent a slight decline from March's 0.32%. However, this drop is not substantial enough to initiate discussions on rate cuts. For the Federal Reserve to consider such a move, the PCE PI inflation needs to consistently hover around 0.2%, signaling a trend towards 2.5% annual inflation.

The Trump Effect on Financial Markets

Donald Trump's recent guilty verdict in the "hush money" trial introduces another layer of uncertainty. This legal setback could diminish his chances of becoming the US president again, indirectly impacting the bond market. The potential fading of Trump's political future raises the likelihood of the Trump-era tax cuts lapsing post-2025, a scenario that might reduce the federal deficit and the supply of bonds, consequently affecting bond yields.

A diminished Trump candidacy could also benefit Mexico and its currency, the MXN. Under Trump, there was a higher likelihood of imposing restrictions on inbound manufacturing capital from China, which would have hampered Foreign Direct Investment (FDI) into Mexico. This restriction could weaken Mexico's external balances and the value-added in its exports to the US.

Market Reactions: Stocks and Bonds

Stock indexes have been under pressure recently, affected by a combination of factors. Asian markets, particularly China and Hong Kong, reacted negatively to disappointing macroeconomic data. China's headline manufacturing PMI dropped to 49.5 in May, falling below the critical 50-mark, indicating a contraction. This downturn was driven by declines in new orders and new export orders sub-indexes.

In the US, the softness in stocks over the past week and a half appears to be a delayed reaction to rising bond yields. These concerns were echoed by the Dallas Fed's Lorie Logan, who noted that high US interest rates might not be restraining the economy as much as expected. This sentiment was further supported by recent inflation data from Europe, where the Euro area's May flash headline CPI and core CPI both came in higher than anticipated, suggesting persistent inflationary pressures.

Dow Jones Industrials Average
Dow Jones Industrials Average© Getty Images/Spencer Platt
 

Implications for Monetary Policy

The ongoing focus on inflation, both cyclical and structural, underscores today's critical discussion about the April US PCE PI inflation report. While the report is expected to align closely with consensus, it won't significantly deviate from the already-reported CPI and PPI figures. An in-line core PCE print would mark only a slight decline from the previous month, insufficient to prompt the Federal Reserve to consider easing rates. For the Fed to contemplate rate cuts, the PCE PI inflation would need to consistently show figures closer to 0.2% on a monthly basis.

Trump’s Legal Troubles and Their Economic Ramifications

As the analysis of Trump's "hush money" trial conviction continues, its potential impact on the presidential election and subsequent economic policies becomes more apparent. A conviction could alter the political landscape, affecting both presidential and congressional races. This shift could influence US economic policy beyond 2025, especially regarding bond yields and inflation.

The geopolitical and domestic policy outlooks are intertwined with the election outcome. Some analysts argue that a non-Trump presidency could prolong geopolitical uncertainty, particularly in relations with Russia and the ongoing Ukraine conflict. Conversely, Trump's proposed policies, such as deporting undocumented workers, could be inflationary.

Traders are inclined to believe that a conviction and a reduced likelihood of Trump returning to office would lower US Treasury yields. The rationale is straightforward: Republicans aim to extend the Trump-era tax cuts, while Democrats would prefer to let them expire, reducing the deficit and the supply of bonds.

Mexican Elections: A New Era of Economic Policy

Mexico is also on the cusp of significant political change, with a general election scheduled for Sunday. Claudia Sheinbaum, representing the left-wing MORENA, PT, and PVEM parties, is poised to win the presidency with a majority of 52-56% of the vote. Her victory, however, is not expected to secure a super-majority in the House of Deputies, leaving the legislative balance of power relatively unchanged.

Sheinbaum's approach to policy appears more technocratic-left than the populist-left stance of her predecessor, Andres Manuel Lopez Obrador (AMLO). This shift could herald a more market-friendly environment, reducing some of the uncertainty and risk typically associated with Mexican elections.

The US-Mexico Economic Relationship

The outcome of the US presidential election will significantly influence US-Mexico relations. A Trump victory could introduce new restrictions under the USMCA, particularly regarding Chinese investment in Mexico. This scenario would likely reduce FDI into Mexico, weakening its external balances and the value-added in its exports to the US. Conversely, a Biden victory would maintain the status quo, fostering robust FDI inflows into Mexico's manufacturing sector, including investments from China.

Given these uncertainties, predicting the MXN's performance by year-end is challenging. A Trump win could undermine confidence in the MXN, while a Biden victory would likely bolster it. Current projections place the USD/MXN at 17.25 by year-end under a Biden presidency and 17.50 under Trump, with a weighted average expectation of 17.35-17.40.

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