High inflation is a risk from Trump policies after decisive win
Amid uncertainty over the extent, timing and sequencing of Donald Trump’s policies, one global fund manager is bracing for higher inflation and downside risks for the global economy.
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The S&P 500 is up 3.7 per cent and the Russell 200 Small Caps index has soared 6.1 per cent within three days of a resounding victory for Trump and Republicans are on track for a sweep of Congress.
The 10-year Treasury yield looks to be carving out a higher range, the US dollar has crept higher, gold looks to be finding support and Bitcoin has continued to soar with Donald Trump’s blessing.
Australian shares slipped on Monday as China’s latest fiscal stimulus plans underwhelmed the market once again, causing a sell-off in resources stocks as commodity prices fell.
As much as Trump’s “America first” policies may help parts of the domestic economy, they could reignite inflationary pressures, lessening scope for US interest rates cuts.
They also pose risks for the global economy and trade, with China and Europe in the crosshairs.
While predicted by betting markets, Trump’s mandate for change is much stronger than expected and a red sweep of congress isn’t the benign outcome that many investors would have preferred.
Amid uncertainty over the extent, timing and sequencing of Trump’s policies, AXA Investment Management chief investment officer Christopher Iggo is keeping some of his fund’s firepower in reserve, albeit that’s partly due to uncertainty about what comes next after such a strong year.
“I think that would be the case anyway, because we’ve had such strong returns,” Mr Iggo tells The Australian. “I mean this year has been a gift, really, for investors, because of that kind of Goldilocks macroeconomic backdrop that has been associated with very strong returns from US stocks in particular. Globally, equities also did well and around the middle of the year, bonds did really well.”
AXA IM is a global, diversified asset manager with about EUR844bn trillion ($1.37 trillion) of funds under management and specialist expertise across every asset class and a broad range of strategies.
Uncertainty about the extent, timing and sequencing of policies comes at a time of stretched valuations in stocks and corporate credit after strong gains in the past year.
High yield credit has been one of his biggest bets this year, but valuations are now “rich”, with 10-year US Treasury yields likely stuck in a 4.25-4.75 per cent range for some months.
“Where you look at the credit spread, that’s got very tight and as a result we already cut back a little bit level of risk – still positive, but less positive than we’ve been earlier in the year, because you’re just not getting that additional return from credit that makes it worth having a big bet on credit.
“With the additional uncertainty now, if you take, for example, triple B rated US investment grade bonds, the spread is in the bottom 20th percentile of the range of the last 10 years.”
It also comes amid receding expectations of interest rate cuts and expectations that China will eventually deliver large scale fiscal stimulus to restart consumer confidence amid a damaging property slump. China’s policymakers have disappointed investors all year, but they may be waiting to see Trump’s policies.
“Uncertainty is the big challenge for investors,” Mr Iggo said.
“Our view was pretty positive on the growth outlook anyway because growth was being spurred by really strong investment spending, particularly around the IRA (Inflation Reduction Act) and Chips Act, which has encouraged companies to invest in green technologies.
“We’ve heard that the Trump administration will unwind some of the big acts of Congress, like the IRA and maybe even the Chips act, and that could impact on investment spending and have some negative effects for some companies as well.”
“But I think we now have to assume that whatever Trump is able to do in terms of policy is more inflationary and more expansionary.”
His initial response has been to slightly increase his interest rate profile for the Federal Reserve.
Whereas previously he saw the Fed funds rate target range to be cut to 3.5-3.75 per cent, Mr Iggo now expects it to bottom out at 4.25-4.50 per cent by March. The current target is 4.5-4.75 per cent.
“Obviously, Trump can’t do anything until January, but he could hit the ground running,” he said.
“He’s got Congress behind him, they clearly have a plan for stuff that they want to get done.
“So by, you know, end of January, we should have a pretty good view of what the policy environment looks like and what that means for interest rates over the rest of next year.
“But for now it looks like the Fed can’t ease as much as it perhaps wanted to.”
Mr Iggo sees some parallels to 1995, when the Fed cut three times from July before hiking in April 1996.
“Yeah, absolutely…so it’s an extended kind of cycle, and remember back then, after the first phase of easing, the Fed had to tighten again. So that’s a profile that we can’t rule out, that you know, at some point next year, the discussion will turn to the Fed having to tighten again,” he said.
Trump would clearly be unhappy if Jerome Powell were to lift rates, but he warns that investors would react badly if Trump interferes with the Fed. Any such pressure would risk putting upward pressure on long-term Treasury bond yields, which link to car loans and mortgages.
He expects an early move to extend personal tax cuts and potentially some additional tax cuts for the corporate sector, leading to expansionary fiscal policy when the economy is already “pretty hot”.
On trade policy, Trump may use tariffs more as a threat to drive trade concessions from China, Europe and Mexico in particular, but there’s little doubt tariffs will rise to some extent.
“There’s already been this redirection of trade, with China’s having to rethink its own growth model, which I think is partly a response to what’s been happening with the US, but then what happens in the rest of the world…there’s a kind of domino effect here,” Mr Iggo said.
“When you have this kind of level of protectionism – which generally probably means higher tariffs everywhere – it’s a negative for global growth. And another possibility is that some countries may use their currency as well, to offset any impact of tariffs.
“So a kind of currency war is not great either. All of it adds up to a worse inflationary backdrop.”
AXA hasn’t formally revised its economic forecasts yet, but Mr Iggo said they could be revised down.
“Europe’s the one that gets hit the most I think, because even though the tariffs won’t be as big as the Chinese tariffs, anything that kind of dampens European export growth is going to be negative, and this is an economic region that’s already struggling with Germany already in recession.”
In China recently to meet with clients, Mr Iggo said locals were “guardedly optimistic that they would see a series of stimulus proposals”.
He said the fact that it hasn’t been a “big bang” stimulus was unsurprising given the timing of the US election and Trump’s inauguration in January.
Originally published as High inflation is a risk from Trump policies after decisive win
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