The Trump Bump

The US Presidential election result has triggered contrasting moves in global financial markets. US markets have generally responded strongly, with a soaring dollar, and higher equity and credit markets. But markets in the rest of the world have weakened, with declines in currencies, equities, and commodity prices, largely reflecting concerns about escalating tariffs and trade disruption. The rise in US bond yields represents bigger risk premia – connected to uncertainties in trade and fiscal policy. We are back to pricing a higher for longer interest rate environment.

World markets outside the US have performed very differently. Markets seem to be convinced that a second Trump presidency will be bad for world growth ex-US, in contrast to the more ambivalent view taken by markets after Trump's win in 2016. Lower industrial metals prices, equities, and bond yields point to a deflationary world outside the US. Policy changes have been key to our outlook, we have been positioned for a reflationary environment in the US that delivers both higher growth and sticky inflation. For now this looks set to continue with the US being supported by an expanding business cycle and a strong labour market. Strong productivity growth alongside the impact of past immigration is expected to keep US economic growth high in 2025, regardless of the next administration’s policies. The majority of the fiscal policy we expect is an extension of expiring provisions in the Tax Cut and Jobs Act. The current provisions expire in 2026, so we see little probability that more fiscal policy is pushed through before then. A continuation of current policy will not stimulate growth further.

Over time, immigration changes and tariffs should increase inflation and slow growth. Immigration has boosted labour supply, allowing for rapid economic growth and falling inflation amid rising labour market slack. Consumer spending growth should ultimately weaken as lower immigration and a slowing labour market weigh on aggregate income growth. Tariffs are also stagflationary, delivering stronger inflation but will reduce real wages and moderate consumption growth. Against this backdrop, we expect a slightly higher US terminal rate in 2025. Higher sequential inflation in H1 25 and overall uncertainty about the inflationary effect of new policies may result in a shortened Fed rate cut cycle. Tight immigration policy and deportations imply lower potential GDP or production capacity, so the Fed must restrict demand to conform to the lower level of supply.

In Australia, we have seen very strong fiscal activity supporting growth, which has meant the RBA has lagged the policy easing cycle, despite a faster and a more direct policy channel via variable rate mortgages. But buttressing the Australian economy has been very strong fiscal activity, which is now nearing its pandemic-era share of the economy and set to continue. Put together, the overall restrictiveness of policy on the economy has been less than if one just focussed on mortgage holders and household consumption. Given that the central bank may have overemphasised the mortgage and consumption channel earlier in the cycle, it's now apparent that the overall restrictiveness of policy matters, not just the transmission to mortgage holders. Businesses and the government have been much less sensitive to the rise in the cost of debt financing and it’s been these two sectors driving growth in the Australian economy. With inflation remaining sticky, this sets up Australia to undertake later and shallower rate cuts than peers, underpinning sustained yield support for Australian fixed income assets over the near and medium term given attractive valuations and a supportive cycle.

Positioning

This higher for longer outlook sets up a very appealing environment for the fixed income asset class, with improving valuations and a supportive cycle that will deliver higher levels of quality income.

But high starting valuations in some credit markets and rising policy uncertainty is a recipe for heightened volatility. Valuations can remain elevated for extended periods of time when earnings growth is above average and the US policy rate is down on a year-over-year basis. Furthermore, while the election outcome has boosted risky assets, other important factors have been the reversal of hard-landing fears and an aggressive start to the US Fed cutting cycle – i.e. we’ve priced a lot of good news in a short period of time. We remain constructive on credit markets and have lifted our hedges that were protecting our credit exposures in the lead up to the election, adding back to European credit markets after recent underperformance. Australian credit was a strong performer in November as the demand for the ‘all-in’ yield drove the appeal for the asset class, especially from Asian investors. Swap spreads also continued to move lower and remain at historically tight levels, helping drive further outperformance vs US and European credit markets. Australian credit remains our most favoured market and we expect continued outperformance vs global credit markets in 2025.

Valuations on Australian and US mortgages remain attractive in a higher for longer environment, offering high quality yield and where we are seeing little signs of credit stress in economies. With US yields rising over the month, we added to our US mortgage holdings with agency mortgage-backed securities at better valuations compared to US corporate bonds. We also took profit on our short US interest rate position with the market now looking fairly priced for this reflationary or higher for longer environment under a Trump administration. We continue to hold inflation protection in the US as this remains a cheap hedge against a move to a more stagflationary environment where inflation gets stuck above central bank targets.

Across our interest rate exposures, we are maintaining a bias to Europe where deteriorating economic data in the region (notably from the traditional stalwarts Germany and France) has raised concerns that the European Central Bank (ECB) might need to step up its rate cut pace to secure a soft landing. European rates markets have also benefited from outperformance with the outcome of the US election. The rise in Australian bond yields saw us extend our interest rate risk in the front end of the Australian curve, leaning into more attractive valuations as the RBA holds the cash rate at elevated levels patiently waiting for inflation to moderate.

As we close in on 2024, with macro outcomes and policy still highly uncertain, we will not hesitate to revise our outlook if growth, inflation, or policy expectations deviate from the current ‘Goldilocks’ outcome. We continue to expect a divergence in asset class returns that allows us to actively rotate across fixed income markets to access the most attractive global opportunities.

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Managed Fund

Schroder Fixed Income Fund - Wholesale Class

Australian Fixed Income

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