A world adrift: navigating market uncertainty after the US election
Fiscal developments on this and the other side of the Atlantic over the next twelve months will truly be The Tale of Two Cities
If you don’t know where you’re going, you don’t know when you’re lost. That in more ways than one reflects the prevailing sentiment in markets as well as in politics as the world tries to establish in the aftermath of the sweeping Trumpublican victory of the US elections which side is up. The more recent wave of appointments to the incoming US administration has left many perplexed and outright scared and the most frequently heard comment is that as opposed to 2017, there will in DJT’s inner circle be “no adults in the room”. But if I look back to Trump 1.0, those adults by and large did not last very long and at the end of his first term Uncle Sam had not sunk into the swamp.
I was particularly taken, and this was a line along which I had previously not been thinking, by one commentator who looked at the howling and wailing and gnashing of teeth over the appointment of RFK Jr to the health brief and the hollering that he knows nothing about it who pointed out that our own health secretaries aren’t exactly shining examples of people with deep knowledge and experience in the sector. Wes Streeting who currently covers the portfolio in Sir Keir Starmer’s cabinet holds a degree in History from Cambridge and amongst his more recent predecessors is Savid Javid who came to parliament and then government after a career in banking. But that is just an aside.
US risk asset markets went into overdrive, rallied out of sight, then decided they’d overdone it a bit, reversed and are now looking for a sensible level at which to settle down. Old bond dogs like myself look on with astonishment as equity prices shoot up in expectation that the economy is going to gain a boost when Trump moves into the White House, then decide that if the economy does well rates will not need to be cut and then they fall again. Fed Chairman Jay Powell is somewhat caught in the crossfire but has taken a lesson from Alan Greenspan by donning the mask of the inscrutable sphynx. Well, nearly but not quite. Either way, there is a lot of uncertainty in the futures markets. Will they? Won’t they? If they do, when and by how much? The money markets are supposed to be the home of reason yet their predictive track record over the past year has been anything other than laudable.
Sure, the Fed’s dual brief is to support economic growth and full employment, but it also has to keep a keen eye on the growth trajectory and the probability of it leading to an inflationary cycle. Equity markets have a habit of believing that interest rate policy is primarily here for their benefit and with the amount of leverage embedded in private equity they may not be as wrong as they should be. It is not only the economy, which is swimming on a sea of debt, the equity market is too. Conventional thinking is that equities do well when interest rates are low for the simple reason that the cost of borrowing feeds straight through into profitability and hence into the share price. So far, so good. The private equity game is not about earnings alone. The cost of money is not just one of the drivers, it is the main one.
The question that seems most frequently to end up on my desk is “Is this a good time to be buying bonds?” Given some of the uncertainties of what lies ahead in terms of the inflationary impact of either Donald Trump’s decidedly right wing agenda for the USA or Sir Keir Starmer’s equally decidedly left wing one for this country, who is supposed to make an educated guess? Watching fiscal developments on this and the other side of the Atlantic, in Washington and Westminster, over the next six to twelve months will truly be The Tale of Two Cities. So, are we going to be seeing rate cuts or rate rises, are they going to fall at a much slower pace than anticipated or are they going nowhere at all?
The ECB appears to be the easiest to follow. Growth across the eurozone is anaemic at best and inflation does not look to be a serious issue when it comes to what Christine Lagarde might have planned. The key Deposit Facility is at 3.25 per cent and those with even a short memory will know that the ECB has no fear of taking rates to zero or below if that is what it believes to be necessary. The bet against a series of rate cuts through mid-2025, as many as six of 25 bps, would be bold so that the yield on the German 2 year Bobl at 2.11 per cent and the 10 year Bund at 2.35% don’t in any way look out of place. If the question is “Is this a good time to buy German bonds?”, the answer has to be that that train has already departed.
UK gilts actually look like a better bet, even though Chancellor of the Exchequer Rachel Reeves, that famous ex-Bank of England economist, has quite clearly got her knickers in a twist. Her Mansion House speech of Friday – and I’ll admit to some bias – sounded to me like someone trying to make themselves rather than their audience believe that all is well in the garden. Just a couple of days ago Reeves commented with some frustration that she was disappointed by the economy’s lack of growth in Q3. Really? Did she truly believe that with her and her boss going around telling all and sundry that the Budget is going to be harsh, that government finances are out of control and need to be stabilised that they are going to be going gung-ho investing and hiring? If that is the depth of understanding of a former Bank of England economist – she has already had to back-pedal from her claim to have also been an economist at HBOS – then I cannot but fear for the once legendary discipline of the Old Lady’s economics team.
It is 44 years since the late Margaret Thatcher hit the high note at the 1980 Conservative party conference with her line “The lady’s not for turning”. That had been a pun on the title of the 1948 Christopher Fry play “The Lady’s not for Burning” that was at the time being revived in the West End. Her full line was “To those waiting with bated breath for that favourite media catchphrase, the 'U-turn', I have only one thing to say: 'You turn if you want to. The lady's not for turning!' I say that not only to you but to our friends overseas and also to those who are not our friends.” Had Reeves been a Tory, she might well have proudly quoted Baroness Thatcher, but she isn’t, so she didn’t. The sentiment was the same in that she simply glossed over the areas of her fiscal policies that are not finding favour and tried to placate the City grandees by declaring that regulation had gone too far – I’ve been singing off that hymn sheet for a decade and a half – and that the time has come to cut the banks some slack. The flight into unregulated private debt has been the financial markets’ answer to asinine capital reserve and aggregate risk calculation requirements and it will take time for the horse that has bolted to be recaptured.
In 2007/2008 when the financial system caught fire – Ms Reeves might acknowledge that that was towards the end of a decade of Labour government – regulators were caught with their pants down. The resulting regulatory framework, above all the 30,000 pages of MiFID II, had above all one purpose: if another GFC were to occur, then the regulators would be able to claim that it was not their fault as the regulations were there for all to see and patently clear. That their regulation has simply pushed credit risk off the banks’ balance sheets and into the unregulated private debt market will if, as and when the brown stuff does hit the propeller help nobody other than themselves. Reeves is right although she is of course stating the bleedin’ obvious.
Are gilts worth buying? There are more questions with respect to future borrowing requirements than there are answers and Reeves has made a rod for her own back by committing to spend forecast increased fiscal revenues at a time when those forecasts look rather Panglossian and are being seriously questioned. BofE Governor Andrew Bailey also had his say at the Mansion House and I will surely be coming back to his thoughts. An immediate further cut in UK rates now looks improbable but not impossible but with Bank Rate at 4.75 per cent there is probably value to be found in the belly of the curve where 5 year gilts are yielding 4.32 per cent, to me a better bet than 10 years at 4.47 per cent.
And now to the States. The jury is out as to whether the Fed will be ready to ease one more time in December. I think they will, although I can also predict that the real reason will not be reflected in the minutes of the December FOMC meeting that will come out in early January although before the inauguration. What they will not reflect will be the conversations which will take place between the voting members of the FOMC around the water cooler. For choice most of them will probably not be wanting to ease before they know a little bit more about the President’s immediate intentions. On the other hand, however, they know that some of the more hawkish Trumpists will want to get their hands on the Fed so an ease ahead of the change of government would demonstrate its desire to work in line with the new ideology.
Are Treasuries worth buying? If Trump gets his way, short rates will fall while longer ones will have to rise. US 2 years at 4.30 per cent look to me like a better bet than 10 years at 4.43 per cent. Part of the reversal in US equity markets over the past week is blamed on the prospect for rate cuts beyond the odd quarter point here or there now being seen as slim. The S&P 500 closed last Monday above 6,000 pts. By Friday night it was back down at 5,870 pts, still well above the 5,512 pts at which it had closed the Monday before the elections. That said, however, month over month it is all but unchanged. The great Trump rally is proving to some extent to have been smoke and mirrors.
Do I buy bonds here? Barely a week goes by without someone writing an article somewhere declaring that the 60:40 portfolio - 60 per cent equities, 40 per cent bonds - is dead and buried. Banks are still enthusiastically feeding the private debt and private equity markets. The latest figure to be doing the rounds is that AI, if it is to reach its full potential, will require a trillion dollars of investment, not least of all in power generating capacity. I saw how much good money was burnt in the dot.com boom and bust and I know to my own detriment how much went into the blockchain revolution, never to be seen again. The money is of course not gone, it simply belongs to somebody else. For all the Nvidias there are plenty of Theranoses.
There is never a reason not to buy bonds. The decision has to be whether to buy short, medium or long. Over the past two years or so the front end has been a great place to be. If pressed, I’d suggest that in a US context that has not materially changed.
So, off we trot into a new week. Can anybody recall when President Ronald Reagan decided that the best way to “defeat” the Soviet Union was to militarily outspend it into oblivion? He succeeded. Over the weekend I was treated to the words of a former military gentleman of some standing but who shall be nameless and who opined, surely not without solid evidence, that Russia really is running out of money to further pursue its military aims in Ukraine. With the numbers which he shared with us in mind, the decision by the Biden administration to agree to Ukraine’s deployment of advanced long distance weaponry might well be aimed at pushing Putin over the financial edge. This will not have been done without pretty clear intelligence that the Kremlin will not go nuclear. Sadly, I have very little faith indeed in US military intelligence which has a flawless track record of seeing what it wants to see. That said, the gentleman in question is very British and boys and girls at GCHQ have overall been a little bit better than their American cousins. I do hope they are right.
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