Trump Bump; Fed & BoE cut 0.25%
Author: Tom McGrath CIO, 8AM Global
Market Review
Last week was never going to be dull, and so it proved, with the US election completely overshadowing central bank policy updates. As the polls and bookies suggested, Trump won. Still, the winning margin was much greater than expected, and the Republicans find themselves potentially controlling the trifecta of the Presidency, Senate and House of Representatives (although the Democrats have a long shot to reclaim it). Thankfully, there has been no dispute over the result or riots on the streets. The US equity markets loved the news, as investors piled broadly into stocks and specifically into ‘Trump Bump’ stuff such as financials, crypto and Tesla shares. Global investors proved less enthusiastic with falls in the UK and Europe, although perhaps surprisingly, given the tariff threats, we saw gains in the Asian region. Bond investors initially appeared much less sanguine about the result, driving yields sharply higher, before calming down after the Federal Reserve cut rates as expected and J Powell delivered the appropriate reassuring noises.
The Return of ‘The Donald’
Like him or loathe him, the American people have voted, and Donald is back in for a second term, as enough voters in pivotal states were won over by Trump’s focus on inflation and immigration. There can be no doubt of the validity of the result; the presidential win was comprehensive, and it looks like the Republicans will also have control of the Senate and the Lower House. He will be sworn into office on 20th January, emboldened by the result and unchallenged by his party; he has already indicated that he is prepared to move swiftly on core economic priorities such as raising tariffs, cutting taxes and cracking down on undocumented migrants.
The market reaction was emphatic as shares closed out their strongest week of 2024. The S&P 500 reached its 50th record high of the year, briefly surpassing the 6,000 mark and ending the week up 4.7%. US equity funds saw an inflow of $20 billion on Trump’s victory day, the highest in five months. Small-cap domestic stocks, perceived beneficiaries of corporation tax cuts and proposed tariffs on overseas competitors attracted the largest inflow since March.
Investors’ enthusiasm is centred on optimism that Trump’s pro-growth promises of tax cuts and deregulation will supercharge an already buoyant economy that is also (incongruously) further stimulated by Fed rate cuts. Given these unusual circumstances, who would challenge the notion that an already expensive stock market can’t get even more expensive? At this stage, you have to feel (as we’ve highlighted) that there is the genuine prospect of a melt-up market scenario unfolding. Clearly a lot of retail and institutional investors do not want to miss out on that chance.
Federal Reserve Meeting
The Federal Open Market Committee (FOMC) cut the federal funds rate by 25 basis points as expected. The decision would have been already made irrespective of the election result. Still, a total 75 basis points reduction since September, given the economy’s and labour market’s ongoing strength, looks excessive. Fed Chair Jerome Powell confirmed this strength, noting both are ‘in a good place,’ yet insisted that monetary policy remains restrictive with the rate above ‘neutral.’ Powell’s remarks imply continued rate cuts, though he did at least acknowledge that there’s no rush given the economy’s robustness. This raises the question: if conditions have improved, why is another cut urgent? I wonder how fast they might have to pivot next year if they consider current conditions restrictive, especially given some of the inflationary policies of the next President!
Is Inflation really no longer a worry?
For the last few months, investors’ primary focus and concern has been the state of the jobs market, asking whether rising unemployment was a signal of recessionary times ahead. Now, I think it is time to return to watching inflation data more closely and see how bond markets react to any change in direction. The Fed changed the language in their accompanying statement on Thursday, removing reference to ‘further’ inflation progress, noting inflation ‘has made further progress’ toward the committee’s 2% objective but remains somewhat elevated. It also removed the statement that the Fed ‘has gained greater confidence’ that inflation is moving sustainably toward the 2% target. I know that sounds like semantics, but these little changes are the means by which the Fed telegraphs potential shifts in stance, and they appear to be getting a little more wary.
This was the case last week when new unit labour cost growth data revealed that employment cost inflation is rising again. Additionally, revisions to prior data indicate that labour costs have been rising faster than previously estimated. While this supports economic strength and improving living standards, it also suggests that inflationary pressures remain.
Given this news, it was all the more surprising that US bond yields fell last week, but the treasury bond auctions showed there was still high demand at current levels. At some point when the euphoria calms down, something has got to give in the financial markets, as both equities and bonds can’t keep moving in tandem together indefinitely. I suspect the bond markets will break cover first, and we see the US 10-year yield moving back up to 5% as investors realise that inflation under Trump is likely to head up. I have never known an instance where tariff increases proved deflationary.
UK rate cut & what did the BoE make of the budget?
Chancellor Rachel Reeves’ first UK budget has so far met a lukewarm response from both the equity and bond markets, with concerns that the additional £142 billion in borrowing could stall the BoE’s plans for rate cuts. So, there was great interest when we heard what the Bank of England made of it. Despite acknowledging that Reeves’ tax-heavy budget could drive inflation up by 0.5% to a peak of 2.8%, Governor Andrew Bailey announced a rate cut of 0.25% and diplomatically spelt out that there were no immediate changes to the planned rate-cut trajectory. Cue: essentially zero reaction from either gilts or UK equities, seemingly much more interested in events in the US.
The BoE has now already lowered rates twice in Reeves’ term, and despite the budget, it looks like more are on their way as it projects further rate cuts to 3.75% by the end of next year, expecting inflation to fall below target despite fiscal pressure. Bailey downplayed the bond market’s jittery response to Reeves’ budget, attributing it more to the recent US election than domestic factors. He cautioned that it’s too soon to gauge the full impact of the £26 billion payroll tax increase on employers, which could lead to higher prices, lower wages, or reduced profit margins over time.
Regardless of what Bailey said, the BoE has two more threats to inflation on the horizon than they did a couple of weeks ago: an inflationary budget and an inflationary Trump. That has convinced traders that this was the last rate cut of the year. Money markets now imply only a 15% chance of another quarter-point reduction in December, down from about 70% at the start of last month. Investors are also forecasting less easing next year, with markets fully pricing two cuts with a third hanging in the balance. Unsurprisingly, this has weighed on gilts and the FTSE 100, and the UK and US equity markets have again parted company.
We have said it a thousand times: the UK market is now looking about as cheap as it ever has relative to US equities. That doesn’t mean it can’t get cheaper for a while, and only a brave/contrarian global portfolio manager would be overweight UK equities now. At some point, I expect the gap to reverse, although I don’t know when, and I don’t know if that will come about due to US falls or UK gains.
German Surprises?
Forgive the stereotyping, but it is not often” ‘Germany’ and ‘surprising’ come in the same sentence, but last week was just such an occasion. Chancellor Olaf Scholz, a Social Democrat, ended his three-party coalition with the Greens and the fiscally conservative Free Democrats on Wednesday evening by dismissing FDP Finance Minister Christian Lindner. Scholz has proposed moving the next scheduled election to March instead of September, though the opposition is pushing for an even earlier date. With an early election now on the cards, a key question is whether this could lead to a step change in Germany’s fiscal policy, as after years of austerity, Germany is arguably in the best position among all developed countries to resort to powerful fiscal stimulus.
With its export markets facing headwinds from likely US import tariffs and slow Chinese growth, a new government might be more open to fiscal spending to support the ailing domestic economy. German government bonds seem to anticipate more public debt, with the yield on 10-year bonds rising to 2.5% on Thursday. While Germany was set to hold elections next year anyway, the earlier vote might come at the right time to pick a fresh leader ready to tackle the issues at hand and help Europe coordinate a response to eventual US tariffs, which are likely to harm Germany the most. We have been underweight Europe in the portfolios for a long time, but if we get a new pro-growth government in place, it might be time to reconsider that position.
China
China announced a 10 trillion Yuan ($1.4 trillion) relief package aimed at restructuring local government debt by moving hidden debt onto public balance sheets. This initiative, China’s largest since the pandemic, addresses local fiscal strains but stops short of new direct stimulus. Instead, policymakers are preserving room to react to potential trade tensions with the US as Donald Trump assumes office, with their finance minister saying as much and that ‘more forceful’ fiscal policy may be introduced next year if needed. While some analysts expected more immediate domestic support, China’s recent rate cuts and stock market support have already driven a big share bounce, reducing the need for urgent stimulus. While local debt restructuring is crucial, further fiscal steps to boost demand will likely be needed to support long-term growth, particularly as global trade pressures intensify.
Investors will now look to December for the next major window for bigger fiscal measures when the 24-man Politburo will discuss the economy at a monthly meeting. By then, officials could have greater clarity on Trump’s stance on tariffs and more time to devise a fiscal strategy to fireproof the economy, but I suspect they will stay their hand until Trump plays his cards.
There was some good macro news last week other than more policy rhetoric, as China’s export growth surged by 12.7% in October, reaching $309 billion, the fastest pace since July 2022, driven partly by exporters rushing shipments ahead of Christmas and new Trump tariffs. But it does highlight the fragility of the economy, as that reliance on exports may be short-lived if a trade war begins next year. The authorities will have ‘gamed’ a Trump win and stand ready to unleash domestic policy bazookas if trade negotiations go badly. The Chinese equity market seems to constantly surprise global investors. Given that it has been widely telegraphed that Trump is bad for China, the market might flourish under huge domestic policy support.
A cautionary note…
In 2024, Donald Trump’s election win has reinvigorated the stock market, echoing the post-election surge of his 2016 victory. As I highlighted earlier, just like in 2016, small-cap stocks and banks rallied, while the S&P 500 posted a record-breaking Election Day. Yet, despite similarities, this landscape is fundamentally different. When Trump first took office, the U.S. stock market was rebounding from a challenging period. By the end of 2016, the S&P 500 had climbed 9.5% after a difficult start to the year, and the index was trading at a modest 17 times projected earnings. Interest rates were low, with the 10-year Treasury yield at 2.5% and the Fed funds rate at just 0.75%, creating ample room for economic expansion.
Now, in 2024, equities are at unprecedented levels. The S&P 500 has recently reached an all-time high after a 56% gain in just two years and is trading at 23 times projected earnings, 40% above the historical average. In contrast to 2016, interest rates are significantly higher, with 10-year Treasury yields at 4.3% and the fed funds rate at 4.75%. The elevated valuation does imply less upside for equities unless earnings really do take off, which they still well could if economic momentum accelerates and productivity gains continue. However, inflationary risks are also on the rise as Trump’s policies – his protectionist trade measures and immigration restrictions – could scupper all the hard work of the Fed. Now, that will probably affect the bond markets the most, and to my mind, the question for next year is, can equities continue to make gains on the back of strong earnings if Treasury yields are heading to 5% and above?
Possibly, they can, and perhaps all the money pumped into AI can help keep a lid on wage inflation, and productivity gains can keep the price of goods and services lower. That was what happened in the 1980s with the advent of the PC, and most of us can remember how stunning that decade was for equity investors.
This Week…
After all last week’s drama, it looks much quieter on the macro and micro front, but we do get US CPI data and a steady stream of corporate results. According to FactSet, 91% of the companies in the S&P 500 have reported actual results for Q3 2024 to date, and 75% have reported actual EPS above estimates. Looking ahead, analysts expect (year-over-year) earnings growth rates of 12.2%, 12.7%, and 11.9% for Q4 2024, Q1 2025, and Q2 2025, respectively. For CY 2024, analysts are calling for (year-over-year) earnings growth of 9.4%. For CY 2025, analysts are predicting (year-over-year) earnings growth of 14.8%.
This content is intended for financial professionals only. These are the author’s views at the time of writing and may be subject to change. This content is not intended to provide the basis for any investment advice or recommendation. Any forecasts, figures, opinions, tools, strategies, data, or investment techniques are included for information purposes only.
The information presented is considered to be accurate at the time of production and has been obtained from or based upon sources believed by the author to be reliable and accurate, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. Please visit our Regulatory Information and Terms of Use pages for more information.
Production
