Stephen Thariyan, Global Head of Credit, discusses the relatively muted reaction of credit markets to confirmation that Donald Trump has been elected as the next US President.
It is interesting to note that, so far, the reaction in the credit markets has been more muted than expected. Many had been calling for the iTraxx Main Index to be 10-15 basis points (bps) wider on a Trump victory and for the iTraxx Crossover Index to be 30-50bps wider. These indices respectively represent a basket of investment grade and sub-investment grade credit default swap spreads and a widening indicates an intensification of nervousness about the credit outlook.
In the end, the Crossover Index peaked at just 20bps wider and has since settled back below 10bps wider, while the Main Index initially gapped 5bps wider and has settled a mere 2bps wider*. The relatively muted reaction in credit markets – in contrast to the immediate aftermath of the Brexit vote – suggests that positioning among investors is very light. Many investors were caught unaware by June’s Brexit vote and while a Clinton win for many, including ourselves, was a base case scenario, this had led to a flattening of risk positions in advance of yesterday’s US presidential election.
Following on from the initial knee-jerk reaction, many markets (away from equities) have erased and reversed their change on the day. The 10-year US Treasury note, for example, which closed last night at 1.85%, rallied to 1.72% and is now over 10bps wider on the day at 1.95%*. Government bond curves, especially in the US, have started to steepen aggressively as markets are wary of the fiscal stimulus that Trump promised during his campaign. Up until yesterday, it seemed almost guaranteed that the US Federal Reserve (Fed) would hike interest rates in December with the market pricing in a more than 70% chance of a hike. Although the market continues to price in a high percentage chance of a rate hike, to us it currently seems less clear-cut. The two policies that Trump seems most likely to pursue at this juncture are fiscal stimulus and increased trade protectionism, which can be interpreted both positively and negatively for risk assets. Fiscal stimulus is viewed as pro-growth while trade protectionism is anti-growth. The delicate balance between these two key policies is likely to dictate the path of risk assets and credit markets in the near term.
Central bank action in the wake of Brexit was key, with Bank of England Governor Mark Carney immediately calming the markets with talk and following this up swiftly with a rate cut and the introduction of corporate quantitative easing. It remains to be seen if the swift action of other central banks this year will be enough to sway the Fed in December.
The market moves post-Brexit, however, are not a perfect blueprint for what is taking place today and into year end. While the shock post-June 23 was initially just as great, it was then followed with the dawning realisation that although Brexit meant Brexit, the actual economic effect of the UK leaving the European Union would be slow to come through (since Article 50 is still to be triggered).
Although Trump will not be sworn into office until January 2017, change in US policies may appear more quickly. Furthermore, this is the second political shock to hit markets in 2016. Chances are that investors, when reviewing their outlooks for 2017, will now be much more wary of political risk and more weight will be given to the potential ramifications of the Italian reform referendum as well as the French and German elections next year. Investors may look to lock in some of the returns that they have seen in the higher-returning asset classes this year and move back closer to home.
*Source: Bloomberg, correct at 2pm GMT on 9 November 2016.