Monday Espresso Podcast - 28th October 2024

[00:00:00] Sheldon MacDonald: It's the 28th of October. We've had a week in which markets have been dominated by politics and I think it's fair to say that in the next week or two, we're going to continue to be dominated by markets. So let's start on the US side where betting sites are starting to push up the odds of a Trump victory.

[00:00:18] Sheldon MacDonald: Not sure how much to read into that. Remember that on the eve of the 2016 election, those same betting sites were only giving Trump an 8 percent chance of victory. At the moment, they're saying 60%. Anyway, with markets in this frame of mind, trying to think about what's going on politically, Alex, just let's have a quick look back at what happened last week.

[00:00:38] Alex King: Thank you, Sheldon. Yes, we saw a pretty poor performance in markets. Generally, most regions were negative on the week. The hardest hit equity markets were Japan, where we saw a strengthening of the yen ahead of the snap election that we've just seen and the UK ahead of the next week's highly anticipated budget.

[00:00:56] Alex King: Generally we've seen that markets have been impacted by longer term interest rates. The 10 year US rate has been steadily rising since the last cuts in mid September, from 3.6% to 4.2% today and this has clearly had a negative impact on bonds specifically for longer duration bonds which have been underperforming shorter duration bonds.

[00:01:17] Alex King: We've also seen that small caps have been underperforming their large cap counterparts due to this. However, we have seen some pockets of good performance. Chinese equities, for example, have bounced back a little bit from their recent weakness. And in the alternatives space, we've seen precious metals continue to perform well.

[00:01:35] Sheldon MacDonald: So, I want to dig into what you were speaking there about long term interest rates. It's quite interesting that we've seen interest rates rise. All the narrative in recent months has been around rates falling, right? That those policy rates. So certainly the Fed has dropped rates, the Bank of England is dropping rates, we've seen rate falls in the EU.

[00:01:54] Sheldon MacDonald: Why this talk about rising rates? Well, partly that's to do with the election. People worried that a Trump victory might actually see stronger growth and rising inflation expectations. But we've also got this very grand term that's been banded about, US economic exceptionalism. Basically, the US is performing stronger than the rest of the world, and robust data coming through showing us that the US, far from a hard landing, we're looking at a soft landing, potentially even no landing. Essentially, the economy going back to growth, limiting the potential for those rate cuts coming through in the future. So long term rates are starting to discount this possibility, and that's why we're seeing those rise.

[00:02:36] Alex King: Yeah, that's right. There's no secret that the Fed want to lower rates. In fact, they spent more in interest repayments in 2023. Than for national defense budget, they spent $1.1 trillion dollars in interest repayments in 2023. So the fed can control the short end of the curve on the policy rate side but they don't really have that much control over the long term interest rates. It could be that the investors are expecting to see an economy to be Stronger going forward.

[00:03:04] Alex King: That's a possibility. However, given that the economy really isn't all that strong and a lot of strength has been purchased in some form or another, either by a government borrowing or government spending, it could be something else. So it could be higher inflation expectations or lower demand generally for US debt. I think Uncle Sam is kind of caught between a rock and a hard place here. Some people are suggesting that quantitative easing could be an answer, but then that could reignite inflation again, so it's difficult to see what's going on.

[00:03:33] Sheldon MacDonald: Yep. Equally, here in the UK, we're seeing the government faced with similar concerns.

[00:03:38] Sheldon MacDonald: Obviously ahead of the budget this week, lots of speculation around what's going to happen. Probably too much for us to unpack in any sort of detail here. But similarly, debt servicing costs in the UK are high and is a feature of this. Over a hundred billion pounds being paid in debt servicing costs to create room for fiscal spending.

[00:03:58] Sheldon MacDonald: There is an assumption that those debt servicing costs are going to fall. Now that is in line with what we've seen from the Bank of England. The Bank of England is talking a dovish game. So we are still expecting rates to fall in the UK as well. All eyes though, as I said, on the budget this week.

[00:04:14] Sheldon MacDonald: While we're still with interest rates, one asset class which is impacted by rates or is generally considered to be impacted by rates is infrastructure. Now that's an area we've been getting increasingly interested in, in recent weeks.

[00:04:26] Alex King: Yes, we've been very interested in seeing what's going on with infrastructure.

[00:04:30] Alex King: As we've seen, long term interest rates have gone up, however, infrastructure is still performing well. So why is this? Well, the recent outperformance has been largely due to energy infrastructure, which actually has a positive correlation to long term rates and is a lot more pro cyclical. There's also limited political risk ahead of the US election. Trump government, for example, could offer support to the sector via potential for additional energy volumes, whereas a Harris government could support existing assets via tighter regulations.

[00:05:02] Sheldon MacDonald: And of course in the UK we've seen speculation about infrastructure spending here too.

[00:05:07] Sheldon MacDonald: Let's just do a quick whip around. What do we expect in the week ahead, outside of the budget?

[00:05:12] Alex King: Yeah, of course, outside of the budget, we've also got the Germany GDP and CPI data coming out on Wednesday. The Bank of Japan have a rate decision to make on Wednesday that's been widely expected to stay at 25 basis points.

[00:05:25] Alex King: We have core PCE price index and jobless claims coming out of the US on Thursday, as well as a CPI print for the Eurozone on Thursday.

[00:05:36] Sheldon MacDonald: So, lots to keep us interested, and we look forward to speaking to you about all of this next week.