Written by Huw Davies, Investment Manager in the Fixed Income Absolute Return team at Jupiter Asset Management
Globally in 2024, more voters than ever in history will head to the polls as at least 65 countries hold national elections. A significant number of those have already taken place but the biggest event, the US presidential election, is looming ever larger on the horizon.
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Several of these elections that have already taken place have instigated a significant amount of volatility in markets. The South African elections saw the ruling ANC lose its overall majority for the first time in 30 years, but ultimately saw a positive reaction from markets as the new coalition was seen as more fiscally responsible. The Mexican election saw the new incoming President, Claudia Sheinbaum, win too large a majority, concerning investors that constitutional change might be on her agenda, again creating market volatility.
The US presidential election is now, after the withdrawal of Joe Biden, too close to call between Kamala Harris and Donald Trump, which is likely to mean that financial markets remain volatile into the event as investors concern themselves about the potential outcome. We may well see investors and traders reduce market positioning as they wait for the result, further contributing to market volatility.
As fixed income investors one of our main concerns is the potential inflationary impact of a new Trump administration. Donald Trump’s team has made the raising of tariffs on imports into the US and significantly reducing immigration key policies for any Trump presidency. These may turn out to be popular policy measures with the US electorate, but also potentially risk reigniting inflation. Tariffs are a tax on the consumer and immigration into the US has helped with balancing the labour market, as well as contributing to the vibrancy of the US economy of late.
The Trump camp has also raised concerns around wanting to take back some control around interest rates from the Fed. This policy move around the Fed seems a tail risk, but again would be a concern for markets and lead to a rise in forward inflation expectations.
Recession versus growth
There has been a slowing of economic activity over the course of this year and, also with the fall in inflation, real policy rates have been rising in the major economies. This means that real rates are now above the real rate of economic activity and therefore are constraining economic activity.
One of the surprising features of the last couple of years for many investors has been that the significant rise in nominal rates has not slowed economic activity as much as forecasters were estimating. This we believe is down to two factors, first that fiscal policy has been very accommodative and also because real rates remained below zero for a long time and really only moved higher than activity levels at the beginning of this year.
The current real Fed Funds rate is now above +3% and that is too high in our opinion. As economic activity and inflation continues to fall, then real rates can move lower. One of the surprising features of the last few months is that the forward inflation as measured by the market has continued to drift lower, even against the backdrop of geopolitical tensions and periodic rises in the oil price. This indicates to us that the market believes that real rates are too high and need to fall.
It may be, as we approach the US elections and volatility returns, that some renewed weakness in equity markets, along with the fall in inflation, encourages the US Fed to move more meaningfully to ease monetary policy. However more than likely this will be a trend priced into 2025, depending on the outcome in November!
UK Budget
The new Labour government in the UK has very little wiggle room on its fiscal policy given the state of the UK finances and the fear of a repeat of the September 2022 crisis after the disastrous mini budget.
However, one thing that is different in the UK now is that we have emerged from our electoral cycle with a government with a significant majority. This puts the UK in the unusual position, especially relative to recent history, of looking like a haven of political stability against continuing uncertainty elsewhere in the world.
UK equity and fixed income markets look cheap to international peers in our opinion, partially based on some of that political volatility we have been living though. Hopefully the new Labour government will be true to its word and boost the investment and growth profile of the UK economy. However, in the upcoming budget Rachel Reeves will have limited ability to create any fiscal stimulus for the economy. Instead, we should look for innovative supply side measures, such as around UK planning regulations and easing of barriers to trade, that might seek to boost UK growth and investment. Without a better growth profile over this parliamentary term the new government has little chance of enacting many of the fiscal spending and improvements to social services it wants to achieve.
