The market is counting the hours before the next president of the US gets announced next week.
The reality though, is that these elections are such a close call that a lot of market participants worry that we won’t have full clarity on the 5TH of November.
It has been obvious that a lot of investors have been sidelined in the last 2 weeks as the levels of uncertainty of who is going to run the government can take a lot of different market interpretations. The market is pricing Trump as the next president to an extent, but there are a lot of questions unanswered with regards to who is going to be the leader in the Senate and House of Representatives. In the last 10 days, we have seen the so called “Trump trade” take an uplift with crypto rallying, rates selling off and curves steepening along with a more mixed picture in equities. We also had a heavy week in terms of corporate earnings and economic data which painted a mixed picture on the inflation side.
Coming into the week we saw another situation of “buy the rumor, sell the fact” where the long anticipation of further escalation in the Middle East came to a pause, following Israel attacks that evaded Iranian crude infrastructure. Oil traded down 5-6% on the day as concerns around the excess of oil resurfaced while US and European equity futures saw gains. As the week came by, we saw a mixed picture of data which still point out a solid growth path in the US. The Federal Reserve’s preferred measure of underlying US inflation posted its biggest monthly gain since April, bolstering the case for a slower pace of interest-rate cuts following last month’s outsized reduction. On the corporate earnings side we had a mixed bag of results, with the market taking some profit across all indices.
In Europe, inflation accelerated more than expected, matching the ECB’s target and boosting arguments for interest rates to be lowered gradually. CPI rose 2% from a year ago in October, up from 1.7% and exceeding analyst’s estimates for a 1.9% increase. As we stand today, coming on top of higher-than-expected inflation, GDP data also supports the idea for ECB to continue cutting in 25bps increments rather than a 50bps cut. ECB speakers are proactively promoting the “gradual approach” with one eye on the US election outcome which could exacerbate growth risks for Europe.
In the UK, BOE’s inflation fight seems to be extended by the outcomes of the UK Budget meeting. UK chancellor Rachel Reeves’s plans to borrow more after rewriting the UK’s fiscal rules poses an “additional challenge” to repairing the public finances, according to Moodys. The negative market reaction has come as the market digested the scale of the borrowing implied by Reeve’s budget. The chancellor’s package of measures includes a £70 billion annual increase in public spending and an extra £100 billion of capital expenditure. Official projections suggest an extra £142 billion of borrowing that will be needed over the next 5 years. The inflationary nature of the budget caused a 20bps upward move in Gilts with bear flattening as the market priced even less cuts from BOE by the end of next year.
In Asia, we saw China’s first major economic indicators after the authorities unveiled the recent stimulus to come better than expected with the Caixin manufacturing purchasing managers index unexpectedly rising to 50.3 versus 49.3 in September. In Japan, Governor Kazuo Ueda signaled that interest rates may rise in the coming months supporting the yen against the dollar.
Current rate cut expectations across all regions have been dialed back this week with all eyes on who is going to be running the White House and what this implies for markets as the two candidates may pursue different political agendas. One thing that they do have in common is that for now, no one has really pointed out what they will do to decrease the negative budget deficit that the US is facing.
Looking ahead…
I believe one thing for sure is that volatility is not going to subside and one outcome that worries me in the short term, is that we may not have a clear winner in terms of who is really in power across the Senate/House. Of course, this will create opportunities and dislocations which on a tactical asset allocation basis will be good to exploit. All in all, I still share the view that fixed income and especially IG credit is a great spot for carry purposes as you don’t even have to go out the curve to source some good income. On the rates side, I still think the place to be is in European governments bonds despite the outperformance versus Gilts and US Treasuries. If the market is correct and Trump comes into power, I think Europe will be in a worse situation than before and the risk of tariffs will derail any upside revision in growth terms. In equities, we have had a decent run this year, but it seems the US exceptionalism is difficult to derail. The ongoing strength of the technology side is not to be ignored, and I am in the camp that thinks that AI is going to be a very big part of our lives and across businesses. We are still in the phase of AI production/implementation and hopefully in the medium term we will get some more quantitative facts of how this has affected the business world. I remain optimistic about the outcome versus the capital expenditure needed, hence I still prefer US equities as a geographical region. The question that all market participants are asking that have gone through similar events to the upcoming election, is this another “buy the rumor sell the fact” situation and are we up for a proper reversal going into year end?
Written by: Michael Konstantinou, Senior Portfolio Manager
Source: Bloomberg
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