Muzinich Weekly Market Comment: MAGA
Insight
July 22, 2024
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In our latest roundup of developments in financial markets and economies, we consider what to make of the latest communications from European central bankers and a big week for US politics.
Politics and central bank communications dominated price action across markets last week with economic data taking a back seat. Volatility picked up, large-cap equities sold off and commodities weakened. European government bonds outperformed US Treasurys and corporate credit showed resilience - generating positive total returns across the board, with US high yield the outperformer.
In China, the Third Plenum of the 20th Communist Party’s Central Committee concluded. At the four-day closed door meeting, “high-quality development” emerged as the top priority with structural reforms laid out to be completed by 2029 in key areas such as technological self-sufficiency, macro governance, social welfare and the financial system.[1] Policymakers vowed to achieve the country’s 2024 growth target of 5% and manage risks in the property sector, local government debt and small banks. More details are expected to be released in the coming days.
Europe on the defensive
As expected, the European Central Bank (ECB) kept rates unchanged at its policy meeting on July 18.[2] Speaking to the media after the announcement, ECB President Christine Lagarde sounded surprisingly dovish, saying September’s decision is “wide open”, noting that wage growth, the main concern of some committee members, is in line with the Bank’s expectations and risks to growth are tilted to the downside.
The overnight interest rate swap market is pricing in a 75% chance that the ECB will cut policy rates twice more this year, in September and December.[3]
Meanwhile, European Commission President Ursula Von der Leyen was confirmed for a second five-year term by the European Parliament following a secret ballot, where pro-Brussels parties came together to outnumber far-right groups. A key part of Von der Leyen’s strategy is to develop a true European defence union. She has pledged to build a European “air shield” and strengthen cyber security as part of an overhaul of the bloc’s defence capabilities.[4]
In the UK, it remains unclear whether the Bank of England (BoE) will cut rates in August or September, so this week’s inflation data was seen as critical. Both headline and core prices in June remained unchanged from May, increasing on a twelve-month basis by 2% and 3.5% respectively.[5] Services inflation, a key metric for the BOE, disappointed, remaining at 5.7%. However, this was offset by encouraging wage data, with regular wage growth falling to 5.7% in the three months to May, down from 6%.
For now, the market remains split on the timing of a BoE cut, with the overnight interest rate swap market pricing in a 49% chance that policy loosening will begin in August.
All eyes on the US
In the US, President Joe Biden finally bowed into pressure and announced he would not be running for a second term, endorsing vice-president Kamala Harris to succeed him.
By comparison, the Republicans have united behind Trump, who has called for national unity in the aftermath of a failed assassination attempt against him at a rally in Pennsylvania on July 13. These events have propelled Trump to be a firm favourite to win the election in November (see Chart of the Week).
Trump’s Make America Great Again (MAGA) brand of populist nationalism has led investors to rethink strategic allocations and amplified market volatility. A pessimistic interpretation would view MAGA as anti-globalisation, anti-big business and anti-immigration. An optimistic interpretation would suggest less geopolitical risk (with the US having more beneficial international agreements), lower taxes and lower regulation.
For now, these varying scenarios have led equity investors to rotate out of large cap and technology firms that rely significantly on international revenues into domestic small cap securities. Month-to-date, the Russell 2000 is up 8% versus the ’Magnificent Seven’ mega cap tech stocks, while the US regional banking index was up 13.5% in the month to July 19. This may also help explain the outperformance of US high yield.
Chart of the Week – Trump for President?
Source: PredictIt 2024, as of 19th July 2024. For illustrative purposes only.
What does the market make of MAGA?
The reaction from commodity markets would seem to indicate MAGA could be a detractor to global growth, with commodity prices falling accordingly and commodity linked currencies such as the Australian dollar and Chilean peso also underperforming.
For government bonds, populism is typically viewed as inflationary and fiscal deficit building. At present, investors seem to have faith in the Fed’s ability to keep inflation in check, possibly helped by Trump announcing that Fed Chair Jay Powell would complete his term in office, set to run until 2026.
However, a possible consequence of MAGA is that neutral policy rates settle at the high end of projections, 3.50% or higher. The rule of thumb for sovereigns that demonstrate fiscal largesse is that their bond curves steepen - investors demand a higher premium to remain long-term holders.
Month-to-date, 10-year Treasury yields have steepened 10 basis points over 30-year Treasuries. However, regardless of the outcome in November, checks and balances can be expected to remain in place, as we have witnessed following the recent elections in Mexico, South Africa and India.
References
[1] Associated Press, ‘China Communist Party policy meeting endorses leader Xi’s high-tech vision,’ as of July 18, 2024
[2] European Central Bank, ‘Monetary policy decisions,’ as of July 18, 2024
[3] Bloomberg, as of July 19, 2024
[4] Bloomberg, ‘Von der Leyen wins second term with European ‘air shield’ pledge, as of July 18, 2024
[5] Office for National Statistics, as of July 17, 2024
Past performance is not a reliable indicator of current or future results.
This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co. are as of July 22, 2024, and may change without notice. All data figures are from Bloomberg, as of July 19, 2024, unless otherwise stated.
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