Fixed Income: US Election positioning
Prior to the US elections and similar to consensus, we also anticipated a Hillary Clinton victory. However, we were of the view that some parts of the market had potentially overestimated the certainty of Clinton winning the election, which warranted a cautious approach.
As it became clear that Donald Trump would be voted in as the next president of the USA, global markets reacted as expected with a broad – yet relatively muted - risk-off move across asset classes. Within the fixed income market, this was demonstrated by an initial rally in Treasuries; steepening of the yield curve; wider breakeven levels; general spread widening and a modest sell-off in the emerging markets.
Though still very early days, the market reaction – unlike Brexit - has been relatively muted, after the initial knee-jerk sell off. Whilst the initial risk-off trade was understandable, the market appears to be placing increased emphasis on Trump’s plans to boost public spending and reduce corporation tax rather than some of the more extreme parts of his political agenda. Indeed, Treasury markets reversed course on the day Trump’s victory was confirmed, with yields ending higher on expectations that fiscal stimulus will feed through to higher inflation.
The tone of his speech on November 9 was certainly more conciliatory than those he gave during the campaign and may suggest that he understands the need to ‘tone-down’ some of the more aggressive policies of his in order to appease those in Congress.
As we look across the fixed income spectrum, this is not the time to make big directional calls given the likelihood of short-term volatility and nervousness among market participants. We are not looking to make any significant changes immediately on the back of the result. We appreciate there will be movements within sectors as investors digest this, but we await more clarity on Trump’s exact policies before assessing their potential impact on our funds.
As mentioned earlier, credit spreads widened post the election result, and we expect a period of much higher spread volatility. The Trump win and Republican sweep could lead to substantial changes to the Affordable Care Act (Obamacare), which could negatively impact healthcare service companies. However, pharmaceutical companies may benefit longer-term from a reduced focus on drug price increases. The potential for less stringent environmental regulations may lead to higher domestic oil and gas production with the potential for more drilling on federal lands. Looser regulation could also boost the use of coal for electrical generation.
North American steel producers stand to benefit from any tariffs placed on foreign steel imports and the expected increase in infrastructure spending in the US. Meanwhile, modifications to the Dodd-Frank legislation may result in lighter regulations on banks. While this could potentially increase returns on equity, it could come at the expense of creditworthiness as the current regulatory regime requires strict limits on bank leverage and capital requirements.
Rates & Inflation
As anticipated, there was an initial risk off move into Treasuries following the election, which reversed course during the day as markets looked to the possibility of a large fiscal program by the new president. This caused the curve to steepen as inflation expectations increased. Although we envisaged curve steepening under a Trump victory, we were somewhat surprised as to the speed with which it was priced in. With regards to monetary policy, ,the probability of a December rate hike by the Federal Reserve has reduced given the higher levels of uncertainty under a Trump victory. That said it should not be discounted given the Fed’s oft-stated intention to normalise rates.
Beyond the US, any prospect of tapering by the European Central Bank seems less likely due to political instability and expected higher market volatility. Emerging markets have sold off heavily in the last two days and it is too soon to call an end to the risk-off sentiment. However, over the medium term, we expect the effect on many emerging market countries to be limited but we will have to assess any major changes in policies from Trump and the sentiment in the market to put new cash to work in the uncertain times.
For UK and Europe distribution ONLY
Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (Aviva Investors) as at 10 November 2016. Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Some of the information within this document is based upon Aviva Investors estimates.