Michela Bariletti: Everyone knows that 2024 is a bumper year for election as over half the world is going to the polls.
For instance, President Macron, about three weeks ago, decided to join that half of the population and call a snap election in France. When he called the snap election, the market saw sharp movement, and we continue to see volatility on some of the French markets [after the second-round voting too].
This is a sharp reminder that the market will react to certain political news and that we need to continue looking at them.
In the volatile market, though, there's opportunities that could open up for investors that can take them.
"From an investment perspective, we don't have a silver bullet
or a crystal ball that we can look at."
We are long term investor; therefore, we are focused on high-quality credits and instruments with strong covenant. We are opportunistic in relation to the asset allocation, for instance, in terms of public versus private market, primary versus secondary, and we are keen on picking up relative value where we find it.
Given the uncertainty on the macro backdrop we, on average, continue to favour high credit quality names and ones with potentially less risk of rating transition. Also, given the uncertain macro backdrop, and in particular, on shorter term maturity up to about 10 years, we see value in rates but potentially less so in credit.
It's fair to say that from an investment perspective, we don't have a silver bullet or a crystal ball that we can look at, but we need to continue being aware of this risk, and how it manifests itself is important.
Having these four billion people going to the polls means there is a high likelihood that some of the outcomes of those elections are not what the market has priced in.
Michela: No one has a crystal ball, but you can start assessing which type of impact one President versus an another could have, in particular, what are the areas that could impact the market more?
When it comes to what is more relevant, we believe that fiscal, monetary, and trade policies are more relevant for the market, and that could have an unmarked impact.
On the fiscal front, if you think about a Trump victory together with a unified government – if the Republicans take the house and the Senate, for instance – this would be a scenario that most likely will feature fiscal expansion, because you could envisage a full extension of the 2017 Tax cuts and Job acts (TCJA) worth about a trillion dollars.
"One of the questions has to be then, could
the US suffer a mini-budget moment?"
In the context of an economic backdrop that already features low level of unemployment, trend growth, and inflation that is coming under control, we could see that, in a fiscal expansion type of scenario, you may have a fiscal policy, which is it at odds with monetary policy. Unfortunately, we saw the disaster effect of having fiscal policy at odds with monetary policy in September 2022 with the UK mini budget.
To remind everyone, upon the mini budget, the UK Treasury 30-year gilt yield gapped 150 basis points higher, and the Sterling investment grade spreads widened 50 basis points, forcing the Bank of England to step in. One of the questions has to be then, could the US suffer a mini-budget moment?
Michela: The principal risk that we are monitoring is the potential divergency of monetary policy between the US, the UK, and Europe. The US economy has surprised everyone on the upside and continues to be fairly robust with a low unemployment rate probably the lowest they’ve experienced in the past 50 years.
This means partly that the Federal Reserve has had to push back its expectation on when to ease the monetary policy, principally through the lowering of interest rates.
When we look at the UK and Europe it’s a different picture because we don't have the same type of economic strands that we see in the US.
"We are looking at the Bank of England and ECB to stimulate
the economy through the monetary policy."
When you look at the growth prospects in Europe, it's quite anaemic so the European Central Bank (ECB), just cut rates and we are expecting them to at least do another cut during 2024, and we expect the Bank of England to come in with a cut too.
We need to consider that monetary policy tends to take a lag in order to show themselves. It's about 12 to 18 months.
You don't want to see the monetary policy drag on too long before they act, given the length that you have in terms of showing its effect.
The other issue is the level of debt to GDP. We monitor closely debt to GDP across the Eurozone and how that is going to be kept under control. We are looking at the Bank of England and ECB to hopefully stimulate the economy through the monetary policy, and the Federal Reserve potentially to intervene.
We, as Phoenix, expect the Fed to do at least one rate cut this year, probably in September, and potentially two cuts from the Bank of England, in August and November and finally, one more cut from the ECB.
Despite this, we see a potential divergency as a risk, which, as of today, is probably not as significant as earlier in the year.
Michela: The reality is that everyone should really be concerned about the level of the debt across countries because it’s the highest since the Second World War.
In the US we could see the budget deficit remain around 6% for the rest of the decade. The International Monetary Fund was one of the last institutions to raise concerns about the level of indebtedness increasing and what that means is that you might have an increase in the US government treasury supply.
"Saudi Arabia has abandoned the petrol dollar, which is probably the
most underrated recent macro geopolitical development."
We saw last summer how increasing the government supply ultimately caused a sell off and higher volatility and how careful the Treasury has been in their refunding announcement since. But the reality is that the supply is growing. The term premia is still low and there is room for additional volatility in the future.
This is even more important in the context of the de-dollarisation of the global economy. If you look at Russia and China, they have already been effectively headed ‘out’. More recently, Saudi Arabia has abandoned the petrol dollar, which is probably the most underrated recent macro geopolitical development.
Secondly, the pressure on the US Treasury has been that in the post-Covid Emerging Markets recoveries, Emerging Markets economies have made themselves as attractive heavens for their domestic investors, meaning that [US Treasury] is less seen at the anchor for the emerging economies for their savings.
That’s worrisome when you look at the US because it doesn't seem to have a strategy to manage this dynamic or tackle it long term.
Michela: I do credit for a living, so I always tend to see the glass half-empty.
The reality is that when you look at the current macroeconomic environment, and we touch upon the risk to these environments, you probably look at further moderation of inflation - the latest trends are quite encouraging, despite concern about the composition of inflation.
We’re potentially looking at further rate cuts in 2025; we are probably expecting up to 100 basis points in terms of a cut in 2025, in the US and the UK. From a European perspective, we’re also expecting a pickup in growth.
We are looking at the UK GDP and expecting to have growth of about 1.5%, with the US moderating in terms of growth and probably settling around the 2% mark.
"Surprises for some of the investor may not be a bad thing, because
you can take advantage when you see some pockets of volatility."
Based on this potential expectation from the economic perspective, we are expecting spreads to remain tight. However, there are many known unknowns that are difficult to predict, and geopolitical risks being a factor. We’ve touched upon that - around what it means if we have a result from an election that has not been priced in, for example.
We might be caught by surprise but again, surprises for some of the investor may not be a bad thing, because you can take advantage when you see some pockets of volatility.
