Fixed income

President-elect Trump promises tax cuts and increased spending, which could increase inflationary pressure

Scott Thiel |18-Nov-2016

Although details are thin on the ground, Trump’s stance on trade, immigration and fiscal policy suggest inflation will rise in the US. To seek to protect against this risk, read our blog by Fixed Income Fund Manager Scott Thiel.

 


US election implications

Although details are thin on the ground, Trump’s stance on trade, immigration and fiscal policy suggest inflation will rise in the US.

To deliver on his campaign promises, the new administration may well choose to be more aggressive on immigration control. In trade policy, as president, Trump will have authority to withdraw from treaties under specific circumstances and may be more aggressive in existing trade protection policies such as anti-dumping. As for fiscal policy, Trump’s fiscal expansion plan involves both tax cuts and an increase in spending. This means the US government may need to raise additional funding over the next few years.

The impacts of his trade, immigration and fiscal policies are likely to be inflationary.

Tighter immigration control could cause a shortage of low-skilled workers and wage inflation over time. A more protectionist trade policy could push up input costs. The fiscal stimulus could increase US treasury issuance and risk premium, putting pressure on long-term bond yields via higher inflation risk.

Tighter immigration control could cause shortage of low-skilled worker supply and wage inflation over time

In terms of monetary policy, in the short term we expect the path of US monetary policy to remain unchanged under Federal Reserve Chair, Janet Yellen. Barring any major economic shock, in our view the Fed is likely to continue with interest rate normalisation, but in a restrained manner, allowing inflation to heat up.

However, the president-elect could have a big impact on Fed leadership in the next couple of years.

There are two open board seats currently and Yellen’s term as Chair and Vice Chair Stanley Fischer’s term will both end in 2018. With the other potential personnel changes, by early 2018 the Federal Open Market Committee (FOMC) could have a very different composition and we may see a more hawkish Fed in the future.

Potential impacts on bond markets

We think the inflationary pressure in the US, which was already in place, may accelerate in the future. In our portfolios, we remain underweight long-maturity US treasuries and long inflation-linked bonds, aimed at protecting against this risk.

US corporate credits could benefit from the new president-elect’s business-friendly policies such as tax cuts and deregulation. There is now more uncertainty about how the election result may impact emerging markets fundamentals. Trade policy uncertainty could weigh on certain emerging market economies, particularly those that are highly export dependent, and we will remain selective in our investments in this space.

It’s worth emphasising again there are many uncertainties on the path of policy directions under the new president-elect. As more details emerge, investors could change their current assessment of policy directions or implementation risks and we could see more volatility along the way.

Outlook for other parts of the world

Outside the US, there are several important political events coming up in Europe, including the Italian referendum on constitutional reform on 4 December and next year general elections in the Netherlands, France and Germany.

With the rise of populist politics in Europe, we are expecting more political headlines and volatility around these events.

In terms of monetary policy, we believe that the European Central Bank will extend its asset purchase programme beyond March 2017 and its dovish stance should continue to support European peripheral bonds and credits.

In the UK, the Bank of England revealed a much more neutral stance towards monetary policy at its Monetary Policy Committee meeting in November. It is likely to be in wait-and-see mode as any potential impact of Brexit uncertainty on the economy is weighed against rising inflation.

With the Bank of England on hold, much of the political rhetoric behind us, and the stronger-than-expected UK economic data, we think some of the risk premium in UK assets may be unwarranted.

UK gilts have recently underperformed US treasuries, which has made the relative valuation of UK gilts look very attractive to the US.

Scott Thiel
Managing Director, BlackRock’s Deputy Chief Investment Officer of Fixed Income
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This material is for information purposes only and does not constitute an offer or invitation to anyone to invest in any BlackRock funds and has not been prepared in connection with any such offer. 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 financial product or to adopt any investment strategy. The opinions expressed are as of November 2016 and may change as subsequent conditions vary.

Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy.

The BlackRock Fixed Income Global Opportunities Fund is co-managed by Scott Thiel. Companies which issue higher yield bonds typically have an increased risk of defaulting on repayments. In the event of default, the value of your investment may reduce. Economic conditions and interest rate levels may also impact significantly the values of high yield bonds. Fixed income securities issued by governments can be affected by the perceived stability of the country concerned and proposed or actual credit rating downgrades. The fund invests in fixed interest securities such as corporate or government bonds which pay a fixed or variable rate of interest (also known as the ‘coupon’) and behave similarly to a loan. These securities are therefore exposed to changes in interest rates which will affect the value of any securities held. The fund may invest in structured credit products such as asset backed securities (‘ABS’) which pool together mortgages and other debts into single or multiple series credit products which are then passed on to investors, normally in return for interest payments based on the cash flows from the underlying assets. These securities have similar characteristics to corporate bonds but carry greater risk as the details of the underlying loans is unknown, although loans with similar terms are typically packaged together. The stability of returns from ABS are not only dependent on changes in interest-rates but also changes in the repayments of the underlying loans as a result of changes in economic conditions or the circumstances of the holder of the loan. These securities can therefore be more sensitive to economic events, may be subject to severe price movements and can be more difficult and/or more expensive to sell in difficult markets. Overseas investment will be affected by movements in currency exchange rates.

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