Equities and treasuries pumped on Trump

Channels: SAA/ALM, Managers, Risk, Brexit

Companies: LGIM, RLAM, Transamerica, Aegon, Swiss Re

People: Astrid Frey, Tom Wald, Jonathan Platt, James Carrick, Lars Kreckel

As the dust settles after Donald Trump's surprise election win, investors and economists assess the likely consequences of his administration on financial markets. Asa Gibson reports

On 20 January 2017, Donald Trump will be inaugurated as the 45th president of the US. As little as five years ago, that sentence would conceivably be read as the introduction to a dystopian novel. Yet, here we are.

For institutional investors, reality is already nightmarish with low growth and historically low interest rates in developed markets, pushing down yields and arresting returns. What's more for insurers, the investment universe has become trickier to navigate with increasing prudential regulation around the world, making investors work harder for their returns.

Since Trump's victory over Hillary Clinton, US interest rates have surged offering a glimmer of optimism for investors. The yield on 10-year treasuries has risen more than 0.5% since the vote on 8 November, and about 0.95% since it fell to an all-time low of 1.37% in July immediately after the Brexit vote.

The market's reaction so far is likely to stem from expected legislation and policy of the incoming administration, based on the more consistent themes of the president-elect's campaign, such as lower corporate and individual taxes, overseas tax repatriation, increased infrastructure spending and less financial regulation. Regarding the latter, the property tycoon has suggested he would go as far as dismantling the Dodd-Frank act passed by Obama in 2010, which was designed to prevent a reoccurrence of the events that led to the 2008 financial crisis.

"The Fed has been reluctant to hike rates for fear of negatively impacting the equity markets. Now they no longer have to worry about that." Tom Wald, Transamerica

High interest

To initially finance such policy, US debt and federal deficits could increase, at least until higher levels of growth in the economy are achieved, says Transamerica's chief investment officer (CIO) Tom Wald in a blogpost titled Have 'Trumponomics' shattered low interest rate predictions?.

"This all equates to higher interest rates, which is certainly what we have seen in the days since the election," he says.

"Our thinking is that the Fed will raise the Fed Funds rate at its December meeting by a quarter point. More rate hikes are likely to follow throughout 2017."

The lower-for-longer notion that characterised much of the past 18 months has almost been shattered, but the trend emerged before Trump's victory. Senior economist at Swiss Re Astrid Frey says a moderate rate increase was anticipated, and that "the election is reinforcing a trend that had already been there."

Equity party like its 1999

Wald adds: "It has been our feeling that ever since its lone rate hike of December 2015, and the stock market correction that immediately ensued during January and February, the Fed has been reluctant to hike rates for fear of negatively impacting the equity markets. Now they no longer have to worry about that."

The CIO of Aegon's US life insurance subsidiary refers to the continued post-election rally by the four major US equity benchmark indexes, which each hit an all-time high simultaneously for the first time since 1999.

"The Fed now essentially has cover it did not have before the election regarding the market effects of increasing rates," Wald says, adding that the central bank will likely downplay its "data dependency persona and use the next several months as an opportunity to catch up on the lost time during 2016."

Royal London Asset Management's (RLAM) head of fixed income Jonathan Platt agrees, citing higher inflation as a result of Trump's fiscal policies, including tax cuts and infrastructure spending, as a driver behind a rise in global interest rates in the medium term.

"The Fed will be caught between trying to raise rates to dampen inflation without wishing to squeeze the indebted corporate sector too much," James Carrick, LGIM

However, Swiss Re's Frey warns that a rise in interest rates can occur only if a fiscal stimulus results in stronger growth, and that if growth does not materialise and only inflation is in place, equity markets could dive.

Inflating concerns

Frey's counterpart at Legal & General Investment Management (LGIM) James Carrick does not hold any optimism for US GDP growth, claiming the country's demography will be its Achilles heel.

"While the US economy has grown by an average of 3% in the past 50 years, there is a stark difference between growth in the last decade (1.5%) and the previous four decades (3.25%). We believe this slowdown reflects structural rather than cyclical factors. And demographics – not policies – are largely to blame," he says.

With the baby boomers entering their late 50s and early 60s, Carrick says much of the US' labour force growth is driven entirely by immigration and could be diminished under Trump's anti-immigration policies.

"When the labour market tightens and wages begin to rise, marginal workers are drawn back into the labour force. While this extends the length of the economic cycle, our analysis suggests these marginal workers don't prevent wages from picking up. Instead, they are a symptom of rising wage inflation.

"By end-2017, we foresee a tight US labour market pushing up core inflation. The Fed will then be caught between trying to raise rates to dampen inflation without wishing to squeeze the indebted corporate sector too much," Carrick adds.

In contrast, Transamerica's Wald says there could be "pent-up demand" in the economy during the year ahead, "stemming from increasing wage growth, higher personal savings and stronger consumer spending."

"Should these trends result in higher levels of GDP growth, perhaps close to 3% as appears may have been the case in Q3 based on initial estimates, then further rationale will fall into place for higher rates," he argues.

A great known unknown

The uncertainty surrounding Trump's tenure as president will likely add a higher risk premium to US assets, says Lars Kreckel, global equity strategist at LGIM. For equities, most of these effects should be offset by higher earnings growth potential, but for other assets the consequences are not so clear.

"On the one hand, investors may be put off holding US dollar-denominated assets with greater domestic uncertainty, while on the other hand the dollar could benefit from Trump's proposal to encourage US corporates to repatriate some of their overseas cash holdings.

"It's a similar story for fixed income assets. While an initial risk-off reaction has pushed bond yields down, it strikes us that many of Trump's policies could ultimately be inflationary," he says.

The mood among investors is difficult to gauge, much like which of Trump's more radical policies will be implemented. For insurers with exposure to US assets, the landscape looks very interesting again. The surge on the 10-year US treasury yield and stock market rally presents short and medium term opportunities, while the longer term economic implications of Trump's policies remain unclear for investors.

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