• Multi-Asset & Macro
  • Multi-Asset
  • Pensions

Democratic “Blue Wave” - a game changer for financial markets

The Democratic “Blue Wave” scenario has finally happened. Will this be a game changer for financial markets? Find out with David Nowakowski (DN), Senior Investment Strategist and Fabio Faltoni (FF), Multi-asset & Macro Investment Director.

Democratic “Blue Wave”; a game changer for financial markets?

FF: What is all the hype about Democrats gaining control of the Senate? 

DN: It really has huge implications. The results effectively mean that the ‘Blue Wave’ scenario has finally happened: a Biden presidency alongside a Democratic majority in both chambers (House and Senate) of Congress. Republicans become the minority opposition and cannot block laws or appointments that need congressional approval, such as cabinet posts and judges.

One of the most important ramifications is that the likelihood of an even larger fiscal package in the US has increased in probability. For markets, this is fuelling greater expectations around the reflation trade.

FF: Will your outlook for US growth be revised as a result? 

DN: Yes, it will be upgraded, though by how much depends on the size and nature of the fiscal spending. For example, “multipliers” on infrastructure spending are considerably higher than those on transfers, which are partly saved. 

FF: What about reforms around taxation, could this also become in greater focus? 

DN: Definitely; it might not be right away, but we do expect a harsher attitude towards business to grab the headlines at some point once President-elect Biden comes to office.

We do expect a harsher attitude towards business to grab the headlines at some point

Reforms toward taxation of corporate earnings and a more stringent regulatory vision for energy and technology companies have been some of the main pledges throughout Biden’s campaign. In the summer, Biden was explicitly talking about the “era of shareholder capitalism coming to an end”. Investors should therefore start to embed these considerations into their base case scenario.

FF: Larger fiscal spending vs taxation reforms. Which will be the dominant force for equity markets? 

DN: We can get a sense of this by looking at how equity markets behaved in the last couple of days. Equity markets generally moved higher but what is also interesting is the sector rotation that has taken place under the hood. We have seen some of the more cyclical sectors such as financials and materials outperform as it became clearer that Democrats would gain a majority in the Senate and increase domestic investment. On the flipside, Tech stocks underperformed on a relative basis. Rising bond yields alongside fears of higher taxes and new regulation have acted as headwinds.

FF: Onto the million-dollar question… could these moves be sustained? 

DN: Broadly speaking yes. In the House View 2021 Outlook document published in December, we had already outlined our more constructive view on the world economy. This is largely a function of the symbiotic relationship between exceptionally easy monetary and fiscal policy alongside a rapid and robust recovery expected in 2021.

We see potential for the recent outperformance of “value” stocks to continue into 2021

Our view on equities was upgraded as a result. While some parts of the market may now be “priced for perfection” — e.g., segments within the equity growth sector, such as technology — others still look attractive from a valuation perspective. We see potential for the recent outperformance of “value” stocks to continue into 2021, as the economic recovery supports financials and travel and leisure sectors. 

FF: Moving onto fixed income, what has been the market response on the back of this outcome? 

DN: Market moves have been quite substantial in the last couple of days. US Treasuries for instance naturally sold-off, with the 10yr yield moving over 10bps to above 1%, a level last seen in mid-March 2020. Interesting moves also took place around the shape of the yield curve, with US yield curves steepening noticeably, as the Fed’s forward guidance limits moves on the shorter maturities.

The 2s10s curve for instance reached the steepest level in the last 3 years and 5s30s hit its steepest in 4 years. Last but not least, US 10yr inflation breakevens, a barometer of inflation expectations, moved past 2%, reaching levels last seen since late 2018.

Figure 1: US Inflation expectations and bond yields grinding higher
US Inflation expectations and bond yields grinding higher
Source: Aviva Investors, Bloomberg as at January 7, 2021

FF: As yields rise, do we need to prepare for the Taper Tantrum “spectre” to reappear? 

DN: Taper Tantrum 2.0 is not our base case scenario, as the Fed has learned from that communication mishap. Nonetheless, we do expect interest to continue to grind higher and for yield curves to steepen further, even after the moves seen since the start of the year. However, central banks are set to keep policy rates at the effective lower bound well beyond 2021 and maintain quantitative easing (QE) programmes to monetize fiscal deficits, so there is a limit to how much government bonds are likely to rise. 

Ultimately it will all be about inflation. At present, we do not expect inflation to rise materially over the next year, though y/y CPI will jump due to base effects, and then settle down again.

For most economies there will continue to be spare capacity throughout 2021

For most economies there will continue to be spare capacity throughout 2021, keeping inflationary pressures low. As that spare capacity is eliminated however, and with monetary policy set to remain loose, we could start to see inflationary pressures building, albeit from a low starting point, in 2022. Markets should start to anticipate this before it is realised. This may prompt a reassessment of our interest rate outlook as the “Monetary Policy” reset theme moves into its next phase.

Multi-asset & multi-strategy in focus

Related views

Important information

THIS IS A MARKETING COMMUNICATION

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). 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. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. 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. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 138 Market Street, #05-01 CapitaGreen, Singapore 048946.

In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.