On 22nd May, Rishi Sunak surprised the media with the announcement of an election on 4th July. Such a thing had to happen this year and we now ‘look forward’ to the weeks of 24hr news coverage of the election campaign. The result is forecast by both the media and pollsters to be a runaway success and a parliamentary majority for Labour, together with a possible decimation of the Conservative party.
However, this article does not concern itself with the probabilities of the various scenarios, the minutiae of policy, or calling the result, but merely the likely impact of the result on the UK financial markets.
While the media seems very excited about the prospect of a Labour government, the UK financial markets seem less so. The FTSE 100 was lower on the day following the announcement, but this was limited to 31 points, or 0.37% - this hardly signified a market surprised, or made nervous by the prospect of a Labour Government. Indeed, the market seems more concerned about the direction of inflation and interest rates than any ‘tax and spend’ policies likely to be forthcoming from Mr Starmer and his team. Indeed, the gilt market, which a very good barometer on this subject (remember what happened to government borrowing rates when the mini budget was announced under Liz Truss in 2022?) hardly moved the next day. This in turn tells us something.
The gilt market’s reaction to Mrs Truss’ not-so-clever plans for taxation, and consequently unfunded spending, probably did us a bit of a favour in that it demonstrated to the shadow government what the consequences might be if they used their anticipated (by them) forthcoming electoral majority to adopt policies closer to that of Jeremy Corbyn, rather than those nearer to the Conservatives. This is because the UK fiscal deficit is expanding and needs to be funded:
Source: House of Commons Library May 2024
What this means in effect is that, whether they like or not, any UK government is now beholding to the markets with regards to fiscal policy. It must feel quite ironic to Mr Corbyn as we sit here today with a record budget deficit and the highest marginal taxation rate for decades, which would probably have been a similar consequence of his policies being implemented. It possibly also feels ironic to Mrs Truss, as due to higher for longer inflation, government bond yields have steadily increased to the levels seen immediately after her 2022 budget but this time without her assistance. This has less to do with the UK’s fiscal position than it does the Bank of England’s monetary policy committee. We can’t ignore the fiscal deficit, nor the already high level of taxation and its effect on consumption, so the consequence of this is that the Labour’s spending plans mean changes to taxation, notwithstanding ‘stealth’ taxes such as tax band freezing, currently seem restricted to making private school fees VATable and to increasing the windfall tax on oil companies. Hardly dramatic in the short run, although this might have some wider consequences in the longer run, so hence markets are not overly concerned about the prospect of a Labour government.
But what if a Labour secure a large overall majority and view this as a mandate to surprise on the tax/spending side and markets take fright? Well for us as global investors, from an equity perspective we aren’t overly concerned since the UK is now such a small of the global stock market (less than 4% by some measures), so the impact of policy mistake can be limited by simply reducing what is already exposure. In the bond portion of portfolios, we have reason to be alert as UK gilts currently feature. However, again as global investors there is the ability to invest elsewhere overseas, or hold more cash-like instruments, as required.
So, they’re having an election too….
It is unlikely to have escaped the reader’s attention that the UK is not the only major economy with an election this year, although the US version is likely to be, temporarily at least, moved down the headlines in the media, as the domestic version takes precedent.
The US Presidential election is, it has to be said, more dramatic than the UK’s General one. It is also more important as the US stock market now represents over 60% world’s markets, so we need to pay more attention to the candidates’ policies. The background of the battle between Messrs Biden and Trump is too vast to cover in this article, but suffice to say, the outcome could possibly have a more significant impact on the financial markets (let alone the democratic process) than here in the UK. Most of this revolves around the candidates’ different approaches to taxation and spending but also protectionism and immigration. Biden has helped to keep the US outpacing other western nations through his Inflation Reduction Act and the consequential expansion of the government fiscal deficit gives some investors cause for concern and Trump has his own plans on this front. However, unlike the UK, the US has the advantage of owning the world’s reserve currency and risk-free instrument of global choice (the T-Bill). This means that the US has been able to increase its spending without government bond markets protesting – thus far. However, there is increasing awareness of what happened to the UK Gilt market in 2022 and the ever-increasing government deficit is a concern for Republicans, so is likely to lead to fiscal restraint from Trump, as he will need the party’s support in this area.
US Federal Debt as a percentage of GDP – May 2024
However, of greater immediate interest is likely to be Trump’s actions on tariffs on imports and immigration. Clearly his election rhetoric is probably an exaggeration of any likely action, such as 10% tariffs on certain goods, and is more likely to be less severe and targeted at specific goods. Some fear this is inflationary, but this depends on the type of goods he chooses to hit and their significance in calculating inflation. It needs to be remembered that consumers only have so much money and if one type of good goes up in price due to tariffs, then they have less money to spend on other goods, so it becomes a zero-sum game. Biden has already acted on this front, in an attempt to head of Trump.
Immigration is an area where there may be more of a policy impact, as Trump has threatened mass deportation of illegal immigrants and Biden is under pressure to address the level of immigration. However, it is believed that the level of migration into the US has helped to suppress wage growth, which has been accelerating in part due to labour shortages and that inflation would have been higher without it. Deporting significant swathes of working population would clearly have the opposite effect.
While we cannot predict the result, nor what policies actually may be implemented, the important thing to look out for is the impact of any of these on inflation that causes the US Federal Reserve to keep interest rates higher for longer, which could be negative for asst prices. So, the message is not to pre-empt but to adjust our asset mix as any significant policies emerge, whether it’s the US or at home.
NB: On the day of writing, former President Trump was convicted of a criminal offence. Having a criminal record does not preclude him from becoming President again. He is highly unlikely to pull out of the running and it may even encourage people to vote for him, as many Republicans view this as a politically motivated prosecution. However, you never know, so watch this space.
Rockhold Asset Management: 31/05/2024
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