Market Update – Trump Trades and the Central Bank Quandary – from Jilly Mann

Posted by melaniebond

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Much has seemingly changed in the world order in the last couple of weeks, but how much of that change is long term and how much is reactionary?

Whilst certainty now surrounds the Presidency of the United States of America, three key global Central Banks have seen their well laid plans become shrouded in uncertainty thanks to political instability. All of which means that no one trade, not even the much-vaunted Trump Trade, is destined to succeed.

In this update we shall cover the following:

• UK interest rates and the inflation conundrum
• Jerome Powell’s game of cat and mouse
• Germany’s political implosion
• China’s rally
• Winners and losers from a Trump administration
• Conclusion

UK interest rates and the inflation conundrum

Following Rachel Reeves’ Budget of the 30^th October 2024, I highlighted the potential inflationary impact that her changes to the measurement of UK debt could have. The naysayers around this change, were primarily concerned that this would lead to higher interest rates in the UK for longer. The announcement by Reeves could scarcely have come at a less opportune time for the Bank of England. Just as the Bank of England had finally accepted that inflation was under control and so were in a position to cut interest rates, a spanner has been thrown into the works.

This week, the Bank of England did announce a further 0.25% cut in rates, but with a warning that they would have to see what happens from here, before they could signal further cuts being on the cards. Prior to the Budget, market expectations were for a 1.50% cut in interest rates over the next 12 months. After the Budget, those expectations have dropped to a 1.25% cut. In immediate terms, prior to the Budget announcement, the odds-on expectation had been for a 0.50% cut in rates in the November Bank of England announcement, post Budget those odds fell rapidly to a rate cut expectation of 0.25%.

At face value that may not seem like such a significant difference, but the Bank of England were ready to signal the path to lower rates prior to the Budget, yet afterwards, they are far more concerned about inflation spiking again through the Budget outcomes, such as rising school fees, tuition fees and bus fares, than they are convinced that inflation will remain low. Rachel Reeves herself said in her Budget speech that she expected inflation to settle at around 2.5%, higher than it currently is. Her own expectations are for this Budget to be inflationary.

I think that we will see further cuts by the Bank of England, but perhaps not at the speed which we could have expected based on current rates of inflation. This is not good news for borrowers, many of whom will feel the taxation impact of other Budget measures in April 2025.

We have reduced our allocation to UK Gilts and are continuing to do so. The Bank of England (BOE) are increasing new Gilt issuance to £300bn for 2024/2025 and, at the same time, the BOE intends to reduce its balance sheet holdings of Gilts by a further £100bn, i.e. quantitative tightening, reversing the quantitative easing carried out during the Covid crisis. They are assuming that there will always be buyers willing to buy this relentless flow of Gilts, but the sheer volume of Gilts entering the market feels too optimistic to us and will likely push up yields rather than reduce them. We therefore think we have seen the best of the returns from UK Gilts for the time being.

The graph below shows how UK Gilts and the Janus Henderson Strategic Bond fund reacted to the UK Budget and subsequent US announcements.

Immediate to the Budget speech, Gilt and broader fixed income yields rose and valuations fell. This continued through to the US election but started to turnaround at the end of last week as some of the immediate reactionary trades unwound.

The Janus Henderson Strategic Bond fund continues to hold close to 50% in US bonds, but has been reducing the exposure to UK and US Government debt in recent months. This has led to a period of improved performance over the last six months, a rise of around 9% from trough to peak.

We think that we shall still see strong returns from these types of assets in the months ahead, even if perhaps the rally in Bonds won’t last as long or be as deep as it could have been prior to the Government policy intervention. We are reviewing our fixed income allocation to ensure that we are now exposed to the optimum funds to benefit from this changing landscape. In short, Government intervention has added an unwelcome layer of uncertainty to the path of interest rates, but it is not a linear case that all fixed income assets are destined to underperform in this environment.

Jerome Powell’s game of cat and mouse

It is no secret that Jerome Powell and Donald Trump do not see eye to eye. The fact that in one of the more monumental Federal Reserve interest rate announcements in recent times, Jerome Powell, Chair of the Federal Reserve, was being asked if he would resign now that Trump had won the election, shows how much drama surrounds the relationship between the two. Powell was quick to point out that Trump couldn’t sack him even if he wanted to. Not exactly a harbinger for a harmonious working relationship. Nor perhaps a certainty given the incumbent President’s willingness to change the rules accordingly.

The key message from Powell regarding interest rates was a 0.25% cut. The future messaging was that, as with the UK, inflation has been coming under control, the need to cut to buoy the economy was evident, but that a Trump administration built on increasing Government spending could swell inflation and cause the Federal Reserve to pause their rate cutting cycle.

Jerome Powell has been ultra cautious in his handling of this economic cycle and has been accused in some quarters of being too late to cut interest rates, fearing a return to 1970’s style inflation. He finally reached the point where sufficient data was being revised negatively month on month, job data was looking challenging and everyday Americans were struggling to make ends meet, but now the fears of a Trump administration could cause him to hunker down and simply wait and see what happens, rather than reduce interest rates further.

That will inevitably cause further tension between the Federal Reserve and the White House. President Trump won’t be sworn in before the middle of January and so we still think there is some manoeuvrability to cut rates further from where they are without going too far as to be damaging under a new regime, but Trumps’ MAGA (Make America Great Again) campaign requires a prosperous US economy. How he balances increased spending, with reduced borrowing costs for the electorate is an uncertainty that we don’t yet know the answer to.

Germany’s political implosion

Whilst all of the headlines have been on the UK and the US of late, Europe is facing its own challenges. The German coalition Government has collapsed this week after Chancellor Olaf Scholz sacked his Finance Minister, leaving Europe’s largest economy in limbo.

It wasn’t so long ago that we were writing about Angela Merkel’s Germany being the ballast of Europe and almost singlehandedly at times bailing out Europe’s PIIGS (Portugal, Italy, Ireland, Greece and Spain) at the heart of the Eurozone crisis. Now Germany is the country in crisis and is widely expected to hold a General Election in early 2025 to try to restore some stability.

The Eurozone entered an interest rate cutting cycle before the UK, yet still face greater challenges to turnaround the economy than either the UK or US. With Germany’s economy expected to fall for the second year running, it is likely to be the worst performer of all G7 economies in 2024.

The urgency to find a solution in Germany prior to a 2025 election is not helped by fears over tariffs which Donald Trump may impose on Europe. The German economic institute, IW, reported that if Trump carried through on his election promise to introduce tariffs of 20% on the EU, then Germany’s economy could shrink by up to 1.5% in 2027 and 2028. If current forecasts for the German economy come true, then it would be the longest period without economic growth since 1990’s reunification.

From a UK perspective, Sir Keir Starmer had seemingly been relying on Germany as a key ally in his desire to build closer links with Europe in an effort to undo some of the Brexit impact.

Europe doesn’t form a large part of our portfolios at the moment, but we see increased challenges ahead for the region, without even factoring in the Ukraine/Russia war which Trump seems set on attempting to resolve somehow.

China’s rally

Perhaps pre-empting a Trump victory, China have been on a mission to stimulate their economy and bring growth back to the stock market. They maybe foresaw that they needed to be in a much stronger position to challenge the US should Trump win the White House, because the headwinds their economy has faced over recent years, US tariffs and a further cooling of relations between the two superpowers, would potentially see China’s position in global affairs diminish quite quickly.

The graph below shows the performance of the Shanghai Stock Exchange year to date. The spike in mid-September is clear to see. A trough to peak return of over 25% in a matter of weeks is some achievement, but as ever with China, we cannot take the numbers at face value.

China remains a potentially contentious place to invest, clarity over business accounting and the threat of Government intervention mean that at best it should be approached with an abundance of caution, but we cannot ignore China, nor the impact a resurgent Chinese economy can have on the wider Asian region.

This broader impact is one that we are reviewing within our portfolios. Globally, we see protectionism returning to economic policy, which in turn affects trade and exports. For every negative outcome, opportunity arises and we saw this during the last Trump administration. The rest of the world still needs to trade, with or without the US and so this is an area where the dust needs to settle to identify the investment opportunities that may emerge in the coming weeks.

Winners and losers from a Trump administration

Donald Trump’s victory was emphatic. We have questioned the depth of the US political landscape over the last couple of years when considering the candidates which such a huge nation were able to muster. I do wonder if we are seeing the advent of a new ‘Camelot’. Perhaps without the youthful vigour of the initial Kennedy ‘Camelot’, but I sense those days are to come. To all intents and purposes, it feels like the Trump family may well be permanent members of the US political scene for decades to come.

It goes without saying that pro Trump businesses and entrepreneurs should do very well from a Trump regime. Elon Musk looks set for a top job in the Trump administration and that may be positive for technology firms who buy into Trump’s quest to cut costs. It won’t be universally positive for technology firms, as not all of the Magnificent 7 bosses were pro Trump in the run up to the election. Some, such as Amazon’s Jeff Bezos, have sought to demonstrate support for Trump post result, but selective stocks will do well and one senses, that Trump will find ways to potentially punish, for want of a better word, other businesses that were less supportive.

Sectors such as energy, banking, pharmaceutical, prisons and small/mid-sized US companies should do well from a Trump regime. We have already seen that in the immediate aftermath of the US election.

Areas that may struggle will be those such as renewable energy and firms that rely on imports. In essence, the theme of a Trump administration will largely echo his previous time in office. Putting America First is all about boosting the performance of the US economy and so domestic stocks and technology firms centred in and around the US are likely to be the big winners.

The chart above shows the Schroder US Mid Cap fund (green) alongside the Titan Equity Growth fund (red) for the year to date. The US Mid Cap fund is more domestically biased given its preference for industrial and financial mid cap stocks. We see this as a key growth opportunity in the coming months and so we expect our allocation to rise. The chart highlights the optimism towards a Trump regime on a domestic basis, with the spike we can see at the start of November.

We are looking to rotate our portfolios to bring in more exposure to these areas. The election was too close to call ahead of time. The magnitude of the Trump victory, perhaps not in number of seats, but in the majority he has attained across all decision making bodies was larger than could have been confidently predicted.

We have seen the US stock market rally strongly in the immediate aftermath of the election result, but we also saw quite a swing in US Treasury Yields immediately afterwards and those largely unwound over the back end of the week, so some composure is required.

We cannot be blind to the potential investment opportunities that now present themselves in the US, regardless of how unsustainable some valuations seem to be. We do need to be cautious though, because inflation and interest rates are not natural bedfellows of a roaring, inflationary stock market.

Conclusion

I started this piece by referencing reactionary markets and the Trump trade. The Trump trade has been very evident over the last week, but we also expect opportunist investors to take their profits and perhaps see a calming of market movements.

The first hundred days of any US President’s term are always regarded as a significant benchmark. In Trump’s last Presidency, he signed 24 executive orders, along with a host of other bills, proclamations and memoranda. He used the opportunity to roll back regulations finalised during the Obama administration last time, how he will use his first 100 days this time will be a key guide to how his whole term will play out. Whilst there has been an immediate reaction in markets, predicting how many of his election promises he attempts to push through in his early days, will give a better take on sustainable areas for investment as opposed to chasing a reactionary response in markets.

Despite the best efforts of Government, fixed income is not doomed, there are strong returns to come as rates reduce and we saw that relationship play out last week.

Politically and militarily, the world feels paradoxically more unstable, yet more certain, than it has for some time. Trump’s methods are not universally admired for good reason, but he has a history of bringing people together to form resolutions. How dangerous that proves to be in terms of bowing to the world’s despots is yet to be seen, but I sense that we may move relatively swiftly from the bloodshed impasse we see in so many pockets of the world today, to at least the possibility of resolution.

A Trump victory does present opportunities that simply weren’t viable for us before, but we cannot get carried away. Government policy has changed the investment landscape in the near term, we are positioning to take advantage of that, but there are far more nuances to be considered than perhaps the headlines or reactionary trade would suggest.