Tatton Asset Management plc

11/15/2024 | News release | Distributed by Public on 11/15/2024 11:17

Latest news from Tatton Investment Management: Reading Trump’s tea leaves

15 November 2024, 05:00pm

It was an up and down week for global stocks. Markets initially showed confidence in Donald Trump's tax cut and deregulation agenda - but pulled back when Federal Reserve chair Jay Powell suggested interest rate cuts might have to be gradual. The S&P 500 was flat for most of the week but tumbled this afternoon amid rising bond yields. This came against a backdrop of strong gains last week, a sharply higher dollar and weak equity markets in most other regions.


Markets are still generally bullish on Trump's second term. This is easy to understand, but relies on a fair amount of guesswork. We still do not really know how Trump's second term will impact the US and global economies, yet markets are betting on America First. That could be a recipe for some disappointment in the near-term, even if the underlying outlook is positive.

Will Powell disrupt the Trump trade?
The Republican party's victory in the House of Representatives, along with Trump's loyalist cabinet picks, mean the president-elect should have no trouble implementing his agenda. The promise of tax cuts and deregulation lit a flame under US stocks last week, and real (inflation-adjusted) bond yields kept climbing higher this week, suggesting that economic growth is expected to be stronger under Trump.

Positivity was initially helped by expectations that the Fed would press ahead with cutting interest rates, but chairman Powell tempered those expectations on Thursday. According to Powell, the US economy is "remarkably good" and the Fed does not need to be "in a hurry" to cut rates. Looking purely at the data, that is quite clearly true, but ahead of a politically volatile second Trump term (in which Powell's job is up for renewal) it feels like a bold statement. In the short-term, it reminds markets that expansionary fiscal policies can lead to tighter monetary conditions.


Over the longer-term, it sets up a fight over Fed independence between Trump and Powell alongside the Open Markets Committee. US yields hit 4.5% this afternoon, and the increase is starting to hurt stocks. Trump backers are already blaming Powell, and an unwelcome tussle between the two now looks inevitable.

Also on Trump's policy docket are tariffs and deportations, which markets conventionally dislike as they are bad for growth. But the reaction so far suggests that investors think Trump tariffs will mainly be bad for everywhere outside of the US. In the early part of the week, stocks edged down in the UK and Europe, and fell sharply in Japan and China. So, rather than hurting US economic prospects, tariff expectations are reinforcing investors' belief in US economic exceptionalism.


Bond risk for some, bond rewards for others.

The move up in US bond yields was partly about higher expected growth and partly about the Fed - but we have argued for a while that bonds are also reacting to an expected deterioration of the government's debt position. As we argued last week, the best way to see this is in the difference between long-term government yields and the rate offered in bank swap contracts of equivalent maturity. The latter are effectively guaranteed by the central bank, so are therefore a truer 'risk free' rate than government debt. The spread of yields over swap rates keeps widening, which suggests that markets see US treasury debt as genuinely riskier than before, as the chart below shows.

The interesting thing this week was that this measure of government debt risk also increased in Europe. This could be down to political instability in Germany and France (which we cover in a separate article) but we suspect the main reason is that markets expect Trump's policies to have the knock-on effect of forcing European governments to spend more. The most obvious way this would happen is through increased defence spending - should Trump make good on his promise to dial back America's payments into NATO. European leaders might also have to invest more in their economies, once US tariffs bite.

UK bonds, meanwhile, have come down in the last couple of weeks. In Rachel Reeves' speech at Mansion House, the Chancellor talked up the need to improve UK private investment and recognised the importance of financial services for the UK economy. Markets took it well, particularly the message that pension funds might be encouraged to invest money in private companies rather than just government bonds - boosting private sector growth.

Some worry this might destroy demand for UK bonds and push up yields, but the trade off is always about how well growth (and hence tax receipts) is supported. The fact bond yields fell slightly today shows that the trade off is working. We previously noted that UK bond yields had a consistent premium over US yields and were being driven by the latter - but the difference between the two narrowed this week, in a sign that things are expected to be calmer here.


Are markets too pro Trump?

We worry that different parts of the Trump trade narrative do not really fit together. Growth and inflation are expected to be strong, for example, but markets are pricing a comparatively small change in interest rate expectations. Investors also think non-US regions will suffer from Trump's tariffs, but are not expecting other governments to retaliate with tariffs of their own, or else do not think that such retaliations could hurt US growth.

This could be wishful thinking, particularly with regards to China. Beijing is currently stimulating its domestic demand after a prolonged economic malaise, and is expected to beef up economic policy in response to Trump's threatened 60% tariffs. The impression from most onlookers is that Trump caught China off guard in 2016, but in 2024 they are prepared. Beijing's approach to the first Trump trade war was often about appeasing the US president, but there is a good chance that China will be more aggressive this time around. Chinese officials could impose significant tariffs of their own, or withhold certain key exports like cobalt (for which China dominates global production).

This is not to say that we do not believe the pro-US story. We just think Trump's long-term effect on markets is more uncertain than investors currently seem to appreciate. How US companies fare during this period - and their expectations for the near future - will be important to watch. Next week, AI chipmaking giant Nvidia will give a quarterly earnings update, which has become an important day in the market calendar. It is even more important in the current context. We will wait for further signs.