US election: impact on markets and our positioning

Donald Trump has won the race to be US president, with the Republican Party also taking control of the Senate.

Below we summarise the immediate impact of the election on markets, possible medium-term scenarios, and the portfolio positioning of our credit strategies and Asset Allocation teams.

Initial market reaction

The immediate reaction has been higher US bond yields and a stronger dollar[1] as investors price in the likelihood of tighter immigration controls, additional tariffs and the prospect of easier fiscal policy via tax cuts.

This last driver has also resulted in higher US equity markets, but the ability of the Republican Party to pass an expansionary budget rests on them taking control of the House of Representatives. This remains unclear at the time of writing as we await the outcome in key Congressional contests.

Republican sweep scenario

If the Republicans win the House of Representatives, immigration and tariff changes would be combined with expansionary fiscal policy via tax cuts for the wealthy and for businesses. We believe this should be positive for US corporate earnings but could lead to higher inflation expectations. This could be mitigated by lower energy costs if fossil fuel regulation is reduced.

Overall, we believe this backdrop could be good for equities and the US dollar, but less good for government bonds as yields rise. This combination may have a mixed impact on corporate bond markets, as higher yields and stronger earnings offset to some degree. High yield corporate bonds probably would benefit the most, while emerging market credit could be under pressure from tariffs and tighter US dollar funding conditions. That said, there could be relative winners across emerging markets, depending on the geopolitical impact as well as oil price volatility.

Digging into sectors, the financial and energy sectors could benefit from looser regulation, while the global auto sector could suffer from higher trade tariffs.

What if Trump fails to take the House?

If the Republicans fail to take the House, the impact could be very different as Trump would be able to apply policies that weigh on investor sentiment such as tighter immigration controls and high import tariffs, but without the pro-growth policies that require congressional approval such as corporate tax cuts.

The impact on US government bond markets would be mixed, with changes to tariffs and immigration offset by the lack of fiscal loosening. The medium-term impact on yields is therefore probably neutral, which is also broadly true for the US dollar.

Equity and credit markets could be negatively impacted by the lack of tax cuts and the potential boost from deregulation if the Republicans manage a clean sweep. Emerging markets could be particularly negatively impacted given the potential for higher tariffs.

Our credit strategies positioning

Duration: We are neutral to a little overweight given the recent back up in yields as well as the ability for government bonds to better hedge credit risk now that inflation is under control.

Credit risk: We have a neutral overall credit risk exposure. Credit spreads are historically tight and there’s little room for further compression overall, but we can still find parts of the market that are attractive. Overall, we are more inclined towards profit-taking.

Other risks: We have recently been increasing our liquidity buffer by trimming tight valuations issuers in our portfolios waiting for better entry points in credits.

Our Asset Allocation positioning

We didn’t have explicit election positions in our portfolios before or through the event. With polls, betting and prediction markets not pointing to a clear outcome ahead of the elections, we didn’t see an edge to take positions, or any attractive opportunities.

We will now look at how markets behave relative to our expected scenario, and for dynamic strategies, we could look to lean against moves that look overdone or counter to our expectations. We have not made any changes yet.

Looking through the election at the wider macro backdrop and positioning of our portfolios, we see inflation moving towards target across developed markets and the US growth outlook remains robust. Moreover, there are few signs of short-term weakness in corporate earnings. Consequently, we are tactically positive on equities in aggregate.

Elsewhere, we remain neutral on government bonds, although the recent repricing in interest rate expectations is beginning to make valuations appear attractive to us and continue to see positive diversification benefits from our fixed income allocations as the equity bond correlation has turned to be negative.

We continue to believe that the risk and reward trade-off in investment grade credit is unattractive, with dynamic portfolios underweight the asset class.

We should not read too much into portfolio performance impacts on such a short horizon, but broadly speaking it has been positive for most strategies given equities are rising and they make up the majority of risk for many growth-orientated portfolios.

 
[1] Source: Eikon, LGIM, as at 6 November 2024.