Market Musings 180125: Europe, UK Stocks Surprisingly Hit New Highs

18th Jan by Edmund Shing

11 comments 1228 reads

Market Musings 180125: Europe, UK stocks surprisingly hit new highs

Surprise surprise! European and UK stock markets hit a new all-time high this week...

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Reversing Trump Trades: Higher long-term US interest rates, stronger US dollar

From late September last year, until a week ago, one of the clear Trump trade winners has been the strength of the US dollar, reinforced by the rise in long term interest rates, ie US Treasury bond yields. The 10 year benchmark.Treasury bond yield had risen from 3.6% at the low in September to touch 4.8% at the beginning of this year, more than 1% higher. We saw a similar reaction in Europe, particularly in the UK, with a similarly sharp rise in the 10 year gilt yield, ie, the UK government bond yield.

So we had a twin movement here, which was driven principally by

the strength of the US economy,
the expectations that the arrival of Donald Trump in the White House will reinforce this growth, and
the potential inflationary impact of Donald Trump's policies, which in turn, have driven interest rates higher.

We should recognize that this is an unusual series of events at a time when the US central bank, the Federal Reserve, has been cutting its benchmark Fed funds rate to 4.5% from a peak at well over 5%.

Usually when the US central bank cuts interest rates, long term interest rates, ie, bond yields, typically fall. However, in this case, the reverse has happened. While the Fed funds rate has been cut, certainly over the last few months, long term interest rates have actually risen.

This is important in the US because it has a number of impacts on certain sectors, most typical, most particularly on the housing sector, where the key source of financing is set according to the 30-year fixed mortgage rate. Typically housing activity is stimulated when this fixed mortgage rate falls below 6.5% but at the moment, given the rise in long term bond yields, the fixed mortgage rate is actually at 7%, which is clearly keeping a…

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mortimer

18th Jan

a helpful read thanks

The Phoenix

Re long term yields theres line of thought that in the US 7 trillion of existing debt needs rolling over this year and another 2 trillion raised for current year spending.

By all counts the US government has financed the last couple of years by using money held in the reverse repo account to buy short term treasuries, the repo account is now nearly empty.

Is the above accurate Edmund in your opinion and if it is how will they manage to shift nigh on 9 trillion of debt whilst keeping/forcing interest rates further down ?

Regards

Andy

Edmund Shing

19th Jan

Hello Andy

A very good question. I am not sure whether the. $7 trillion of debt you refer to is all government debt, or total debt including eg corporate bonds.

In any case, the US treasury does indeed have to refinance at of maturing debt this year,as well as an additional amount of debt from the ongoing budget deficit.

There are several solutions, at least in the short term. Firstly, a lot of this debt can be refinanced by issuing short-term bonds, which in turn tend to be bought by money market funds. Remember that there is nearly $7 trillion these money market funds, used as high interest savings accounts in the US.

Secondly, pension funds should increasingly be big buyers of long-term US bonds as they can Now lock in much higher returns to match their long-term liabilities, ie future pension payments.

But thirdly, I suspect that at some point, the Federal Reserve might eventually also have to help by restarting some form of bond-buying program.

But this is a good argument for saying that Trump will not be able to cut taxes as easily as he did in his first term, as the debt situation is very different today.

Best

Edmund

Thanks Edmund if they did restart QE would this add to the inflation issue as per 2020 covid or would it more mirror 2008/9 when huge amounts of QE were done but we only got inflation in asset markets as money didn't filter out to the general public as it did in covid ?

Well Andy

that would depend on whether the US government actually tries to reduce the budget deficit at the same time, or allows the budget deficit to become even greater. My guess is that Scott Bessent as Treasury secretary would not allow wider budget deficits to occur so government spending would not grow even more, while also I think there would have to be a tacit understanding that any such Fed actions would also require an effort on the part of the government to not be reckless in spending more money they do not have…

The bond market would also exercise its judgment too - if government policies were seen to increase the risk of eventual default, bond yields would rise further to reflect the extra risk, potentially overwhelming any help the Fed can give.

Thanks Edmund even though Trump has made some odd appointments I had heard Bessent is competent.

ACounsell

Hi Edmund,

I recognise you were referring to the USA particularly but the positivity expressed in this section certainly does not apply to infrastructure in the UK Investment Trust sector even though the probability is that UK interest rates will fall faster than the USA:

One clear beneficiary of lower long term interest rates, particularly in the US, is the infrastructure sector, because infrastructure tends to rely on long term debt financing to put big projects such as road, rail, air and even bridge construction into place.

This tends to be a good sector for long term, steady returns, particularly for investors looking for income combined with income growth, so that they can protect themselves against inflation over the long term.

Picking out a few investment trusts to liiustrate my point - sadly I hold all of them!

HICL Infrastructure (LON:HICL): 1 year share price -13.2%, Discount to NAV -28.64%

BBGI Global Infrastructure SA (LON:BBGI): 1 year share price -10.5%, Discount to NAV -19.32%

3i Infrastructure (LON:3IN): 1 year share price -2.3%, Discount to NAV -14.97%

and then the very worst of the bunch because it is involved in renewables which nobody wants to know (I could include Gore Street Energy Storage Fund (LON:GSF) and Bluefield Solar Income Fund (LON:BSIF) but the pain is too much!) is:

Renewables Infrastructure (LON:TRIG): 1 year share price - 27.3%, Discount to NAV -33.61%

Maybe there is hope in 2025 and provided these Investment Trusts continue to pay out decent income I guess we have to be patient for some form of recovery.

Epitychia

20th Jan

Excellent in depth article.

I have a simpler view. Trump is an agent of chaos and no one really knows what will happen, including Trump. People he appoints last only a short time, 12 months is unusual. I doubt Scott Bessent will be in post this time next year. A major increase in unpredictability and risk.

Markets including equity, bond and property need to price in this extra risk, which means a fall in these markets.

John LA

Trump will try hard to avoid inflation, the US infrastructure is crumbling I think Trump approach will be huge deregulation sifting spend from federal to small businesses encouraging competition.

Trusts with a US weighting will grow, infrastructure spending will grow in US, can expect a Marshall plan approach to L A

Disrupting will be an agent for change and Musk challenging the complacency of government should bring big upsides. THe UK needs this approach in my opinion.

Market Musings 180125: Europe, UK stocks surprisingly hit new highs