With clarity, conviction?

Not much going on here, away from a UK budget, US election, snap election in Germany and continued conflict in multiple regions. An initial look at markets might have you believe Artificial Intelligence has already solved all our problems. Cynicism aside, much can be gleaned from all these? events and in certain instances we do at least have some certainty and direction. Without further ado…a summary of market reaction and sentiment.

Macro

No matter your political stance and views on characters involved, one thing is for sure – having a new President taking office with a unanimous decision across the governing bodies in the US is a positive. The disruption and upheaval of the previous election served no good. Hopefully we see a push towards peace, or at least reduced conflict in those regions where populations continue to be displaced, and, at least from the rhetoric, this has a chance and is certainly on the agenda. Whilst a Trump victory had reportedly been the expected outcome, the market reaction was strong, and more importantly, positive. Stocks have once again reached all time highs. We have also seen the cutting (of benchmark interest rates) continue. With several new governments in place, one trend is clear. The populace is fed up with the incumbent, and change has been the vote.

An unexpected surprise has been the snap election in the European economic giant, Germany. Concern remains though, and if anything increasingly so, with budgets being stretched further in order to pay for said change. This is most evident when looking at the repricing of government debt across much of the developed world, as not only fiscal policy is adjusted (be that taxes or tariffs) and more ambitious spending plans have been drawn up. Sadly, it is one of those instances where the burden of interest payments could hamper us all, given not just the outright cost to borrow but of course the scale of that (growing!) debt pile. Should faith be lost much like we saw in recent history with the European Sovereign debt crisis, we are potentially in for another few lost years of stagnant economies and the absence of real wage growth. I don’t think anyone wants a sequel of that, the first movie was bad enough thanks!

Risk

Unbelievably we are less than 2 months out from the end of the year. The war in the Ukraine has continued unabated, we have seen escalation in the Middle East, and rates have not come down anywhere near as quickly as experts told us they were going to back in January.? One might expect this to have caused significant drag on stocks. But no. Across the global major indices, the only outliers to have actually dropped in value over the course of ’24 are Brazil, Mexico and France. For the most part, outside of that we are looking at double-digit returns, before rebasing for USD which has seen a significant rally particularly in light of inflationary policies likely to materialise in the not too distant future and once again meaning higher for longer…So far this year we have seen the S&P break new highs over 50 times, over double the long-term average. Money does appear to be getting pulled from other international exchanges post US election, following both US optimism but also the likelihood?

of America-first in many things. This all before potential deregulation and tax cuts. Not everybody saw this coming. Let’s spare a moment of silence for the hedge funds that shorted Tesla into the election, wiping out more than $5Bn over the weekend.

Credit

Despite higher rates for longer and all the potential reasons for widening, credit spreads remain tight and funding conditions good within investment grade public markets. It is, though, becoming a tale of two cities as private market debt looks like an opportunity for the braver investors out there given the backdrop of diminished bank appetite and capacity to facilitate. (Remember this is not investment advice!). Despite some efforts to reduce the influence of shadow banking, unintended consequences of additional regulation are clear. Yet to be truly felt is the impact of continued net issuance from governments far and wide. With more debt chasing the same pool of?

liquidity one should expect the landscape to shift with spreads widening across the board. Likely to be lost on most was a very recent bank failure in Europe, a stark reminder of what can go wrong. Last month news broke of the failure of the European American Investment Bank AG in Austria, where for some the EUR 100,000 insured piece has done little to protect total cash placed. Queue lengthy process of liquidation, claims and processing of what is left to then finally be distributed to depositors there. If you can take security, face the safest and most heavily regulated, and/or access the very highest rated entities, why wouldn’t you? Complacency kills.

EUR

The cutting cycle continues here unabated. Headwinds for this future path of interest rates not coming from Club Med, rather the economic machines of France and Germany where both have opted for snap elections (as if we didn’t already have enough countries going to the polls in the course of the last few months!). ECB members have now been highlighting the potential for (and need to prepare for) trade negotiations from both the US and China. Thus far we have seen three rate cuts and the fourth in December has been all but guaranteed by voting members when publicly discussing all things economy. The speed is now driven by three factors, being the inflation outlook, the makeup and dynamics of it and the strength of monetary policy transmission. Investors see the potential for rates to drop below 1.5% in less than 12 months.?

GBP

The budget was not quite a lettuce but perhaps a bit of a rhubarb. Perishable. The rates market remains volatile, but generally going in one direction, being higher. In part the budget is seen as inflationary with spending set to increase. The difficulty remains in balancing books and so naturally expectation is for higher borrowing which has already led to higher market rates needed to clear the decks. Sadly this has eroded much of the headroom and assumptions made by Chancellor Reeves. Probably leaves Blighty with higher taxes, budget cuts or most likely a combination of both. Whilst employment data released earlier in the week pointed to a cooling labour market, it has not been significant enough to disrupt the medium to longer-term outlook. In short, pay up (4.8%), unemployment up, vacancies down. Despite cuts to the base rate, that pesky future path of base rate being steeper has actually made mortgages more expensive, again.

USD

A slightly untimely Fed meeting a day after the election. Although given the result less contentious than might have been. Powell rightly signposted that current conditions nor politics would affect any decision and as expected we saw a further 0.25% easing last Thursday. We know policy will likely be inflationary going forward, thus the Fed seems behind (or below) the curve at this particular juncture. I’ll be as bold as to say the entire market is once again wrong regarding the degree to which we should expect both the size and frequency of cuts currently envisaged. Terminal rates a full percent below where we are today still seems rich. The economy remains strong, but also resilient if the recent past is anything to go by. One should not discount the impact of lower taxes that are proposed in this consumer-led economy. Additionally, GDP growth remains above trend, both retail sales and durable goods orders are strong, wages are rising in real terms and jobless claims remain low. Corporate profits are high, margins look good and default rates are actually still in decline!?

What’s not to like?! Let’s leave that there.

So what?

Well, a degree of political stability from the country that brings you more than 25% of global GDP is a good thing. The polls tell us there is a need for change across the board. Thus, reasons to both be cheerful but cautious, as inevitably we are in for continued uncertainty. Whilst some indicators in developed nations are pointing to not insignificant upward price pressures, cooling economies will require further easing by way of rate cuts in the coming months. There is also likely to be greater divergence particularly US vs EU given the differing domestic backdrops. As is always true, it is always a good time to be thinking about risk-adjusted return and diversification with regard to cash. It will always be the lifeblood of every business out there.

*TreasurySpring’s blogs and commentaries are provided for general information purposes only, and do not constitute legal, investment or other advice.