Aviva Investors fund managers Edward Hutchings, Liam Spillane and Max Burns offer their initial thoughts on what the US election means for financial markets.
Read this article to understand:
- What the US election could mean for various financial markets
- Why volatility may persist as investors try to gauge the outlook for US policy
- Why the US will struggle to get its deficit under control
After a bruising US election campaign, Donald Trump is set to become the country’s 47th president. At the time of writing, the Republican Party appears to be heading for full control of Congress, meaning the election is likely to have a major impact on the economic outlook both in the US and the wider world.
Financial markets are likely to remain volatile in the coming days as investors try to get a better understanding of just what the US election result means for economic, fiscal and monetary policy in the US and beyond.
Although President-elect Trump and the Republicans are widely expected to change or cancel many of his predecessor’s flagship spending programmes, such as the Inflation Reduction Act, any savings in government expenditures and revenues from tariff collection are likely to be dwarfed by the various tax cuts he has proposed.
Some of these are new, and others extend cuts he put in place in 2017. If his policies were enacted in their entirety, they would likely result in an appreciable widening of the deficit, from an already historically high level.
According to independent analysis by the Penn Wharton business school, the President-elect’s campaign tax and spending proposals would add $4.1 trillion to the primary deficit over the next decade, which would add around ten percentage points to the country’s debt:GDP ratio in ten years’ time.
While these fiscal policies should boost economic growth in the short-term, President-elect Trump has also vowed to impose tariffs of 60 per cent on all imported Chinese goods and ten per cent on goods from other nations.
The tariff proposals raise the risk of a tit-for-tat response from other nations
These tariff proposals raise the risk of a tit-for-tat response from other nations which could lead to lower economic growth, higher inflation and potentially tighter monetary policy. With the US unemployment rate already low, a commitment to deport a larger number of undocumented migrants could depress growth further and exacerbate inflationary pressures.
Add into the mix the President-elect's desire for a weaker dollar and the potential for greater contention in relations with the Federal Reserve and it seems likely financial markets are in for a more turbulent period as investors await greater clarity on just what a new administration will do, and how other nations and the US central bank respond.
Given its implications for both the US deficit and inflation, the result has already pushed up US government bonds yields.
Edward Hutchings, head of rates at Aviva Investors says while the election result was not entirely unexpected, with US Treasury bond yields having been creeping higher for three months in the run-up to the poll, the market is likely to remain under pressure as investors try to gauge the outlook for US policy.
“The Treasury market was already having to absorb a lot of debt over the next twelve months. It might be the world’s most important risk-free asset, but it doesn’t mean it is immune to concern over the scale of fresh supplies,” he says.
Hutchings says while the short end of the US yield curve could suffer as the market continues to rein in expectations of how far US interest rates will fall, looking further ahead it is the long end of the yield curve which could be under the greatest pressure given the outlook for fiscal policy. This “curve steepening” has indeed been the knee-jerk reaction, with two-year Treasury bond yields up ten basis points, while ten and thirty-year yields rose 20 basis points.
Liam Spillane, Aviva Investors’ head of emerging market debt, says the Republican Party’s clean sweep was the outcome which held most concern for emerging-market debt investors.
“The reason is that it most likely means a stronger dollar, higher US rates and increased tariffs on exports, especially from China and Mexico,” Spillane says. The Mexican peso, for example, weakened around three per cent versus the dollar in an initial reaction to the election outcome.
He believes emerging-market debt and exchange rates are likely to remain under some pressure as investors digest just what the election result means, although it is local currency debt that is likely to bear the brunt of selling pressure with debt denominated in US dollars less badly affected.
“Even though asset prices had weakened over the last few weeks in anticipation of a Republican victory, I suspect they were some way from reflecting a Red Sweep,” he says.
“None of this is good from an emerging market perspective,” Spillane adds.
With lawmakers currently gathering in Beijing, he says investors will be eager to see how China responds to the US election result and the increased threat of tariffs.
US equities on the other hand could be further boosted by the election result, at least in the near term. President-elect Trump’s pledge to slash the corporate tax rate to 15 per cent from 21 per cent will boost earnings, as will his promise to increase defence and infrastructure spending.
Various other policies, such as slashing government regulation and reducing environmental restrictions, are also viewed favourably by many US corporations, especially banks and the construction industry. On the other hand, the result will be far less positive for other industrials and renewable energy companies that have benefitted from President Joe Biden’s various stimulus programmes.
Looking further ahead, other nations’ likely tit-for-tat response to US tariffs could have potentially negative consequences for companies and consumers on all sides. Such a scenario would tend to favour companies focused on their domestic economy relative to those reliant on foreign markets and suppliers.
“A Trump Presidency will likely benefit industrial companies with significant US manufacturing footprints, whilst penalising industrial companies that outsource from abroad,” says Max Burns, global equities portfolio manager and head of equity research at Aviva Investors.
As for the dollar, it has risen further in the aftermath of the poll, having already climbed about three per cent on a trade-weighted basis since the start of October in anticipation of a Trump victory. We believe it has room to appreciate further as the president-elect’s policies mean the US economy is likely to continue to outperform those of major international peers.
