Rates React To Politics
In recent weeks, markets have endured significant political events?that have mostly raised rates amid expectations of increased issuance, among other factors. That was most true for the UK Budget’s massive tax rises still falling short of spending increases, stoking the deficit. The clean sweep by Republicans in the US election also probably means more borrowing, albeit driven by tax cuts instead of spending increases. Then, most recently, the German government collapsed after its hawkish finance minister (Christian Lindner) from the FDP was sacked.
Alastair Newton believes markets should not have been as surprised as they were by UK Chancellor Rachel Reeves's budget speech. But they are right to be nervous about the absence of anything resembling a road map for reform. She needs to improve for her traditional Mansion House speech on 14 November (see UK Budget: Where’s The Plan? ).
In the US, Donald Trump won the election with scope to implement his plans as the Republican Party also took the Senate and is likely to retain the House in a clean sweep. The nonlinear geopolitical risk of an inconclusive political void being exploited has safely dissipated, clearing the way for renewed equity market strength. Structural US economic outperformance of Europe will likely increase amid renewed deregulation. Meanwhile, fiscal deficits should stoke the term premium and curtail rate cuts (see Risk Clears On The Western Front ).
Central banks know that fiscal loosening pressures monetary policy to be tighter than would otherwise have been necessary. The impact isn’t enough to negate the perceived tightness of policy, so expected rate cuts still occurred but are unlikely to extend as far as others have dovishly hoped. We maintain our relatively hawkish call for gradual cuts to end in H1 broadly. Although the Fed didn’t overtly react to the election result, it was noncommittal about cutting in December with data dependence allowing it to transition towards an early end to easing when the data demand it.
The BoE also matched widespread expectations and cut by 25bp to 4.75%. As we forecast, only one MPC member hawkishly dissented, although the overall news wasn’t dovish. Tax rises feed substantial upwards revisions to the inflation outlook that postpone and shrink the BoE’s expected undershoot of the inflation target until 2027. Gradualism discourages cutting until the impact becomes clearer with pay settlements in the new year. So, we still expect the BoE to pause until February before cutting again (see BoE Cuts Between Pauses ).
Rising unemployment in Sweden made it the most dovish central bank with a 50bp rate cut this week. Meanwhile, the RBA , Norges Bank and Negara Malaysia were on hold. Most central banks are reluctant to signal how far they might go. However, the Central Reserve Bank of Peru accompanied its expected 25bp cut with a declaration that the real interest rate was close to neutral, so it?warned markets against extending a dovish move. Indeed, Brazil ?intensified its hawkish policy reversal as the cyclical global leader?with a 50bp rate hike instead. Continuing Brazil’s one-year lead on the Fed suggests US hikes could return before the end of 2025, also consistent with 1998.