The US vote is coming into focus
Last week was quiet, with no significant economic data releases, so markets continued to take cues from the US election polls. The US dollar rose and bonds declined. Surprisingly, stocks fell. It’s hard to attribute these dynamics to a single event. Trump had earlier taken a slight advantage in the polls in all swing states, though still within the margin of error, but his advance faded last week. The US dollar index, alongside US Treasury (UST) yields, have in our opinion risen too fast on Trump given that the economic backdrop hasn’t changed much. With the presidential race so tight and the outcome so unpredictable, we expect some volatility as results start to come in next week.
Last weeks fall in equities could be attributed, in the absence of other major news, to the rise in US bond yields. US bond yields have been rising since September (which we anticipated, leading us to tactically reduce our UST positions), making it more expensive to borrow money at a time when interest rates are still elevated.
Uncertainty about the US elections and the potential for a ‘Red sweep’ (Republicans winning the presidential election and both chambers of Congress) could exacerbate concerns about America’s deteriorating fiscal situation. In 2016, when Trump was elected, interest rates were much lower at 0.5%. So, this time around, fiscal and foreign policies, i.e. tax cuts and tariffs, could matter for the market as new debt will be issued in a higher-rate environment.
From an investment perspective, the potential for volatility is a reason why we’re still holding an ‘insurance’ instrument (where clients’ knowledge and expertise, as well as regulation, permit). This financial instrument appreciates when the equity market declines, limiting the potential negative impact on performance.
Attention returns to the real economy
The US Federal Reserve’s (Fed) latest views on market conditions revealed that regional Feds saw little change in economic conditions across their districts since early September, somewhat contrasting with recent positive economic data. Fed officials still see monetary policy as restrictive and anticipate further cuts in November and December. However, recent US economic data have been strong and could thwart the Fed’s plans for cuts. Last week’s fall in jobless claims put upside pressure on the upcoming nonfarm payrolls (Friday), although they could ease after a strong print last month. Overall, economists expect the US economy to have grown 3% in the third quarter (Wednesday). All this data highlights the economy’s resilience. Perhaps a favourable reading around the 2% inflation target (Thursday) could limit the current market fears and support the rate-cutting outlook.
Inflation is at or below target in Europe as growth slows
Last week, purchasing managers’ indices showed that the European economy is still contracting. This is mainly due to the recession in the manufacturing sector, as services activity is still growing. We believe economic growth data for the third quarter (Wednesday) will continue to show the divergence between core countries and the periphery; the latter enjoying much more favourable economic momentum than the former. Overall, inflation is likely to remain on average below target on average across the Eurozone (Thursday), bolstering the case for sequential rate cuts by the European Central Bank. For now, expectations of lower interest rates have helped European stocks to remain at/or close to their historical highs. However, this position is under review given the weakening growth environment and with a lack of other positive catalysts in sight.
UK markets to focus on the Budget
On Wednesday, the UK Chancellor will outline in her speech, her plans for taxation, spending and borrowing, along with a new set of fiscal rules in her speech. The Office for Budget Responsibility (OBR) forecasts, Treasury costings and Debt Management Office gilt issuance plans will also be published. The market is likely to focus on how far potential tax increases and investment spending will go.
While the conditions are different from those in play at the time of the 2022 ‘mini Budget’ episode, the gilt market is showing some increase in volatility. Our expectation is that the Chancellor will seek to strike a compromise between growth and stability, avoiding any measures that might destabilise the market. In 2022, the market reacted negatively to what it perceived as an excessive level of spending funded via debt issuance.
