As Donald Trump prepares to be inaugurated, questions will be raised surrounding the economic impacts of a second Trump tenure. Answering some of these questions is Iain Stealey, International CIO for Fixed Income at J.P. Morgan Asset Management.
“With today’s US presidential inauguration, the nation stands on the brink of a new political era. As investors and market participants prepare for the incoming administration, it’s crucial to remember that the potential for implementing policy often diverges from the reality of executing it. This distinction will be key as we navigate the months ahead.
Economic fundamentals: a solid foundation
“The US economy enters this new era on a robust footing. Key indicators suggest that economic growth remains strong, with consumer confidence on the rise and the private sector thriving amid looser financial conditions. Wage pressures, once a significant concern, are subsiding, and the labour market has rebounded, alleviating the need for further Federal Reserve rate cuts. Inflation, a critical metric for the Fed, is nearing its target, signalling progress toward economic stability.
“Yet, despite these positive fundamentals, the political landscape remains complex. A political red sweep does not guarantee carte blanche for the new administration. Policies on tariffs, deregulation, and immigration will continue to play significant roles, and the uncertainty surrounding their order and scale makes it challenging to predict their precise impacts. For instance, tariffs can have varying effects across regions, especially as global dynamics shift, with China becoming less reliant on the US.
Valuations: a cautious repricing
“The market has already begun to reprice in anticipation of more expansionary fiscal policies, deregulation, and easier financial conditions. This repricing has prompted the Fed to adopt a more cautious stance on monetary easing. Recent data, such as the substantial increase in job creation, has pushed US yields to new highs, with 10-year Treasury yields climbing significantly. This shift marks a departure from last year’s trends, with steepening yield curves indicating a positive carry and roll-down.
“In the past, the relationship between stock and bond returns has been inversely correlated, with bonds serving as safe havens during equity sell-offs. However, in an inflationary environment, this dynamic can change. As inflation begins to decline, the traditional equity-bond relationship may gradually reassert itself. Rising yields could make stock valuations appear more expensive, potentially leading to a correction in equity markets and encouraging investors to re-enter the fixed income market.
A shift in duration exposure
“Investor behaviour has also shifted, with many reducing their duration exposure. According to a recent J.P. Morgan Asset Management survey, some investors have even taken short positions, resulting in a market that is generally less long. This shift presents an opportunity for fixed income investors, as owning duration becomes appealing from a positioning standpoint, providing a potential technical tailwind.
Opportunities and risks
“For fixed income investors, the current environment presents both opportunities and risks. With appealing valuations and a positive yield curve, now may be an opportune time to gradually increase duration by purchasing bonds further out on the curve. Rising rates could reignite the stock-bond correlation, where a sell-off in stocks leads to a rally in bonds. Additionally, continued Fed rate cuts could benefit carry strategies and the long end of the yield curve.
“However, the primary risk lies in the potential for additional fiscal stimulus, such as expanded tax cuts, which could trigger a resurgence in inflation. With significant liquidity already in the system, any further stimulus that sparks a growth and inflation shock could lead to a Fed rate hiking cycle, for which markets are largely unprepared.
“As the new administration takes office, it is crucial for investors to remain vigilant. While the market anticipates swift policy enactment, the reality is that policy changes may take time to implement. In the meantime, the robust state of the economy, coupled with a rebalancing labour market and slowing inflation, may allow the Fed to maintain a gradual easing bias. As we navigate this new chapter, understanding the nuances of policy implementation and market reactions will be key to making informed investment decisions.”